Positioning credit portfolios for the US election

As the US presidential election draws near, credit portfolio managers are tasked with the delicate challenge of navigating potential impacts on both macro and micro credit markets.

As per analysts at UBS, while the broader macro credit environment is expected to experience minimal disruption from the election, the micro-level impacts, particularly within specific sectors, could be more significant depending on the election’s outcome.

The overall US credit market is positioned for what UBS describes as a “softish landing.” This optimistic outlook is underpinned by a strong technical backdrop and a stable fundamental mosaic.

The possibility of Federal Reserve rate cuts could pull money off the sidelines and push investors further out along the credit curve, creating a supportive environment for credit portfolios.

At the same time, the resilience of the US credit cycle, evidenced by the recent spike in the VIX not leading to a significant widening of credit spreads, suggests that the market is well-prepared to endure the election period without major disruptions.

“We see election-related developments having a limited impact on macro credit, but a greater one on micro credit- particularly if polling starts to separate a clearer presidential winner,” said analysts at UBS.

In the investment-grade (IG) credit space, a victory for Kamala Harris or a significant rise in her polling numbers could benefit sectors like basic industry, capital goods, and utilities.

This anticipated outperformance is largely due to the expectation of continued support for policies such as the Inflation Reduction Act (IRA) and other Biden-era stimulus measures.

On the other hand, sectors such as telecoms, tech, banks, and autos may face headwinds under a Harris administration, primarily due to increased regulatory scrutiny and potential shifts in industry dynamics, such as the accelerated adoption of electric vehicles (EVs).

In the high-yield credit sector, the impact of a Harris victory is expected to be less consistent across industries.

“In our proxy for a Harris victory, we see autos again underperforming per above, ditto aerospace/defense on a less supportive agenda for defense spending, and energy on a more constrained agenda around production and regulation,” said analysts at UBS.

This underperformance may stem from concerns about a less favorable policy environment for defense spending and stricter regulations on energy production.

Looking back at historical data, analysts at UBS found that previous elections have had an impact on credit markets, though the sample size is limited.

Historically, median Baa spreads have tended to tighten in the three months leading up to an election, with gridlock outcomes—where no single party controls both the executive and legislative branches—often coinciding with greater tightening.

Similarly, median Baa yields typically fall during this period, with Democratic presidential victories historically providing a slight advantage for spread markets compared to Republican ones.

Analysts at UBS also employed market-implied analysis to distinguish potential credit winners and losers based on polling swings. They observed that market reactions to changes in the probabilities of a Trump or Harris victory offered valuable insights into sector performance.

During periods when Harris’s chances improved, sectors like basic industry, capital goods, and utilities outperformed, likely due to expectations of continued support for green initiatives and infrastructure spending.

Conversely, in the high-yield space, sectors such as autos, aerospace/defense, and energy were seen as potential underperformers under a Harris victory, reflecting concerns about regulatory pressures and policy shifts away from traditional energy and defense priorities.

Finally, analysts at UBS flagged the potential implications of changes in corporate tax rates and the regulatory environment. A Harris victory could lead to higher corporate taxes, negatively impacting sectors with low effective tax rates, such as utilities, tech, financials, and energy.

Additionally, the regulatory environment for mergers and acquisitions could become more stringent under a Democratic administration, particularly in leveraged finance.