In the run-up to the vote, nervousness was palpable and implied bond volatility returned to its highest level for 18 months. There is nothing unusual about a spike in volatility in the days leading up to a presidential election, but the peaks of previous elections were nowhere near the 136 recorded on Monday - in the last two elections volatility did not reach 80. The day after the election, volatility began to fall in the interest rate options market, but rose sharply in the cash market.
At the time of writing, the 10-year Treasury yield had risen 20 basis points (bps) to 4.47%, approaching the psychological level of 4.50%. The 2-year yield has risen 11 bps to 4.29%. The correction is brutal, especially considering that less than two months ago the 10-year yield was flirting with 3.60%. This trend began in August after poor employment figures led to fears of an economic slowdown and numerous interest rate cuts.
Better-than-expected economic data and an improved economic outlook explain some of the rise in yields. The presidential election and the very likely Republican victory in the House of Representatives explain the rest. Among other things, Mr Trump's program is based on fiscal expansion, notably through tax cuts. This is obviously supportive of growth, businesses and credit markets, but its impact on the deficit and inflation is not viewed favorably by the bond markets.
Another support for domestic growth is the tariff policy promised by Mr Trump. This factor helps to explain part of the reaction in European bond markets, whose yield curves are also steepening, but not through a rise in long yields but through a fall in short yields. The yield on the German two-year bond fell by 9 bps to 2.20%. On this side of the Atlantic, rising tariffs are not good news for exporters. Coupled with a weak economy, it increases expectations of rate cuts in Europe, as evidenced by the steepening of the European yield curve through a drop of the short-end. The steepening of the US yield curve reflects a greater risk of inflation, although expectations of rate cuts remain.
While the dust has yet to settle, the bond markets between the two continents are decoupling, driven by economic fundamentals but also by tariff tensions. The spread between US and German 10-year yields widened from 1.84% to 2.04% the day after the election, compared with 1.50% in mid-September. The next few months will be crucial in determining whether bond markets have "spooked themselves" or whether these post-election moves are a sign of things to come.
