Municipal bond election barometer: Split control, red wave or contested outcome

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      By Craig R. Brandon, CFACo-Director of Municipal Investments, Eaton Vance Management

      Boston - The outlook for municipals bonds is closely tied to the outcome of the US presidential and congressional elections on November 3. We've already discussed what might happen if we maintain the status quo or get a Democratic sweep. Let's wrap up our review by considering three other scenarios — from split control to a red wave to a contested election.

      Split control: Trump wins, Democrats take Senate, or Biden wins, Republicans keep Senate

      Assessment: Likely neutral to positive for muni bonds, depending on further stimulus

      • Under these scenarios, we don't anticipate that much would change for munis — especially if Trump is reelected while Speaker Pelosi and Senator Schumer gain control of Congress.
      • If the negotiating parties can come to an agreement, we might see an overall fiscal aid package in the $2 trillion range, but any stimulus bill would be net positive for munis.
      • Current polls show Biden with the advantage, but the Trump campaign may still have time to pull off the kind of October surprise that shifted the 2016 Electoral College tally in his favor.

      Red wave: Trump wins, Republicans keep the Senate and take the House

      Assessment: Likely negative for muni bonds

      • A Republican sweep could cause equities to rally and US Treasurys to trade off. Munis are highly correlated to Treasurys, so that would hurt.
      • When this happened in 2016, the 10‑year Treasury went from 1.85% on November 8 to a high of 2.60% on December 15, or 75 basis points in 27 trading days — a pretty steep climb.
      • With the economy in a global pandemic-induced recession, the market impact probably wouldn't be as severe this time, but we could see some kind of trade off in rates.

      Contested election: Trump loses and refuses to accept outcome

      Assessment: Negative for muni bonds and other assets

      • In this dreaded scenario, we would almost certainly see a risk-off trade, with significant volatility in all markets. That would bad for everyone, not just muni investors.
      • When the Bush/Gore election was contested in 2000, the S&P 500 Index dropped 10% and the Nasdaq Composite slumped 19% between the election and the end of November, while the 10‑year US Treasury rate fell 52 basis points between the balloting on November 7 and the Supreme Court decision on December 12.
      • Any flight to quality could benefit the muni market through the correlation to Treasurys. But frankly, predicting the reaction from retail investors would be difficult in this case.

      Bottom line: Investors hate uncertainty more than anything, and we fear that nothing could be more uncertain than the risk of possibly not having a peaceful transition of power for the first time in US history.

      S&P 500 Index is an unmanaged index of large-cap stocks commonly used as a measure of US stock market performance.

      Nasdaq Composite is an unmanaged index of the common stocks and similar securities listed on the Nasdaq stock market.

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