NEW YORK (Reuters) - Bond investors are, by nature, a cautious lot.
As they head into the U.S. presidential election on Tuesday uneasy, they say no matter who wins, the government will still have to deal with the “fiscal cliff” and its profound economic consequences. But one outcome in particular - a Mitt Romney victory - adds to their apprehension because it throws into doubt the status of Federal Reserve Chairman Ben Bernanke, with whom bond investors seem to have, well, bonded.
Investors fear that both Democratic President Barack Obama and Republican challenger Romney would struggle to reach a compromise with the leaders of the opposing party in Congress to halt $600 billion in expiring federal tax cuts and automatic spending cuts at year-end.
The lack of a resolution could push the world’s biggest economy into a deep recession, a consensus view supported by analysts at the Congressional Budget Office.
“I think the current situation politically hurts us very badly in trying to deal with our problems economically,” veteran bond investor Dan Fuss at Loomis Sayles in Boston said of the so-called fiscal cliff, his No. 1 worry.
Neither an Obama nor a Romney win will change Fuss’ market outlook. “One of these days, interest rates are going to start up higher,” said Fuss, whose firm oversees roughly $182 billion.
Interest rates recently fell to levels not seen since World War II as a result of the Federal Reserve’s aggressive bond-buying actions. Many warn the Fed is only postponing a destabilizing rise in rates that would hurt economic growth.
The other major issue for bond investors is who runs the Federal Reserve. It is unclear whether Fed Chairman Ben Bernanke will go for a third term when his tenure ends in January 2014, but Romney has said he would not reappoint him if he wins.
A leadership vacuum at the Fed could unnerve investors.
“I would think that who is in charge of the Fed, as opposed to who wins the election, would be a more material driver for the bond market as well as the stock market,” said Bonnie Baha, head of Global Developed Credit at DoubleLine Capital LP, which manages more than $45 billion in Los Angeles.
The yield on benchmark U.S. Treasury notes was 1.74 percent on Friday in the wake of a surprisingly strong set of domestic jobs figures. That puts the 10-year yield, a benchmark for investment returns, mortgage rates and other borrowing costs, in the middle of this year’s trading range of 2.38 percent and a record low of 1.38 percent.
Citigroup analysts recommended in a report published Thursday that investors buy longer-dated Treasuries in case of an Obama win, assuming the market will rally. They also suggest a strategy of using interest rates derivatives to hedge against a Romney victory.
An Obama victory would send yields on U.S. 10-year Treasuries to 1.5 percent or lower from about 1.74 percent now, Barclays analysts wrote, as worries related to the “fiscal cliff” pick up. If Romney wins, some observers believe it’s more likely that the fiscal cliff would be temporarily extended.
If a lame-duck Congress and the White House are not able to resolve their differences on taxes and spending, Bush-era tax cuts will expire January 1, and automatic federal spending cuts will be phased in.
Some analysts believe Romney will have an easier time achieving a deal with Congress to avert the fiscal cliff, but that the compromise might not be to the bond market’s liking.
Positioning for higher interest rates in the options market has grown in recent days, a move which some analysts interpreted as traders anticipating a Romney victory. The expectation would be that increased spending and large tax cuts could worsen the deficit, but this also could spur policies that would help stocks rather than bonds.
Republicans are seen as almost certain to retain their control of the House of Representatives, according to recent polls. The party favors an extension of tax cuts for top wage-earners, while Obama and the Democrats back their expiry, along with higher taxes on top-income groups.
If Obama wins, sparring over taxes for the top two income brackets could lead to no deal and the chaotic response could drive investors to the safety of Treasuries, said John Bellows, investment management strategy analyst at Western Asset Management Co. in Pasadena, California, which manages $460 billion in assets.
“My sense is that there’s more room to compromise between Romney and Senate Democrats than there is between Obama and House Republicans,” Bellows said.
If Romney wins and follows through with his public pronouncements, he will not re-appoint Bernanke as Fed chairman. Some on Wall Street and Washington have criticized Bernanke’s loose monetary policies for hurting the U.S. dollar, stoking gasoline and food prices, and risking a surge in inflation in the future.
Still, many believe the Bernanke Fed has been a catalyst in the recovery of financial markets after they were pummeled by the global credit crunch four years ago.
In a sign of market endorsement of Bernanke’s policies, the Standard & Poor’s 500 has risen 50 percent since the beginning of 2009.
If Romney were to win the White House and select a different person to head the central bank, it would spell the end of an era of easy money from the Fed, said Bellows, who was former Acting Assistant Secretary for Economic Policy under Treasury Secretary Timothy Geithner.
On the other hand, an Obama victory should mean status quo at the Fed.
“If President Obama were re-elected, I think you could expect a continuation of monetary policy that has been laid out,” said Western Asset’s Bellows.
Additional reporting by Sam Forgione; editing by David Gaffen, Mary Milliken and Chizu Nomiyama