Why the Bond Market Remains Calm After the Blue Wave

Andrew Sheets · Morgan Stanley

Bond markets have grown more comfortable with the blue-wave midterm result than the initial reaction suggested.

The initial market reaction to the Democratic sweep was negative, and the blue wave was widely seen as the more market-negative outcome. With the results known, fixed income has become more comfortable. Investors had reduced exposure going into Tuesday, whether because of the vote or broader volatility from technology to Brazil. Uncertainty is now lower because the result is known, so investors should have room to add risk if they choose.

“With the results behind us, and in the cold light of day, I think there are a number of reasons why fixed income markets, over time have grown more comfortable with the result.”at 1:09

Andrew Sheets · Morgan Stanley

If the vote reflects unpopularity of tariffs, tariff policy may change, which could push down long-term bond yields.

Inflation has been too high this year, with tariffs and energy prices both adding upward pressure, and that has weighed on fixed income. If the market reads the election as a rejection of tariffs or certain foreign policies, investors could assume those policies are more likely to change later. That expectation could help push down long-term bond yields.

“To the extent that the market sees these results reflecting the unpopularity of tariffs or certain foreign policy, investors could assume that these policies are more likely to change down the road, and that could help to push down long term bond yields.”at 1:53

Andrew Sheets · Morgan Stanley

The next US inflation print this month is expected to show a notable step down.

Inflation has been a key drag on fixed income this year. Morgan Stanley's economists expect the next US inflation release, due this month, to show a notable decline. This is presented as separate from the election and as a near-term positive for bonds, though no specific figure is given.

“And much more immediately, unrelated to the election, I note that our economists expect that the next US inflation number this month is going to show a notable step down.”at 2:06

Andrew Sheets · Morgan Stanley

Midterm-driven state regulation could slow AI buildout, easing bond supply pressure, though analysts see the AI picture unchanged.

AI spending has generated record bond issuance, pushing up credit spreads and yields and weighing on fixed income this year. Morgan Stanley's analysts do not think the midterms change the big picture on AI. However, if changes in state-level power bring more regulation and a longer buildout, that could ease concerns about supply pressure and any mismatch between the supply and demand for AI-related financing.

“Our analysts don't think that the midterms change the big picture on AI. But to the extent that some changes in statewide power result in more regulation and a more elongated build out, that could help ease some of the concerns around supply pressure and potential mismatches between supply and demand.”at 2:26

Andrew Sheets · Morgan Stanley

Midterm elections have not reliably hurt markets; the S&P 500 rose a year later after each of the last 11.

The S&P 500 was higher one year after each of the last 11 midterm elections from 1982 to 2022, regardless of which party won. The speaker acknowledges this could be coincidence and is not a sophisticated analysis. He uses it to argue that elections matter greatly to the country but do not always matter as much to markets.

“Following the last 11 midterm elections from 1982 to 2022, the S and P 500 was higher one year later after all of them, regardless of the party that won. Now, it's possible that going 11 for 11 is just a coincidence, and this is hardly a sophisticated analysis.”at 2:50