(Bloomberg): Treasury investors spent much of the first half of the year digesting the Federal Reserve’s message that interest rates would stay high for longer and are now waiting to gauge the timing of a rate cut in the second half of the year, plus bracing for risks from the U.S. presidential election.

The second straight month of gains has narrowed the year-to-date decline in the Bloomberg Treasury Index to just 0.15%. To keep rising, sustained evidence of a slowing economy and softening inflation is needed. Treasuries have not posted three or more consecutive months of gains since 2021.

The first presidential debate between Biden and his predecessor, Donald Trump, is scheduled for Wednesday. “Certainly, you can expect markets to be a little more volatile as we get closer to the election,” said Gargi Chaudhry, head of Americas iShares investment strategy at BlackRock.

Neither Biden nor Trump appear keen to halt high deficit spending, and rising U.S. debt under either administration could lead to higher term premiums on Treasury bonds.

Attention during Tuesday’s debate and beyond will also be on whether Trump intends to undermine the Fed’s independence.

“The concern is that regardless of the outcome of the election, the problem of widening fiscal deficits and rising debt as a percentage of GDP is never going to go away,” Chaudhuri said.

France is due to hold national elections soon, but President Macron’s abrupt decision has caused pain for French national bonds.

“No one knows what the outcome will be, but we do know that given the uncertainty, we need to reduce our French bond positions,” Vanguard portfolio manager John Mazzuille said of France.

It remains to be seen whether Treasuries will receive similar treatment as the presidential election approaches, but what is clear is that investors are already widely wary of both candidates’ inclinations to add to the nearly $2 trillion U.S. budget deficit and ballooning debt load through spending increases, tax cuts or a combination.

The U.S. Treasury will issue more long-dated bonds to finance the budget deficit, and increased supply will put upward pressure on yields.

But what worries some investors more is that current long-term bond yields do not adequately reflect rising fiscal and related risks.

The Fed’s model of the so-called term premium on 10-year Treasury notes is currently at about minus 0.27 percent, well below a peak of 0.46 percent in October last year when fiscal concerns were severe.

There is a risk that term premiums could turn positive and widen as the election brings renewed focus on deficits and debt, and that risks could grow if either party takes control of the White House and Congress, as deficit-widening legislation becomes more likely, market participants said.

“It doesn’t really matter if it’s Democrats or Republicans, but either party taking power means deficits are going to get worse, and in that case you’d be comfortable shorting the long end,” said Ed Al-Husseini, interest rate strategist at Columbia Threadneedle Investments in New York. “In terms of term premiums, I think we’re going to see another 50 basis points or so of increases,” he added.

Economic data and Fed policy remain the primary focus for many investors as the election approaches, but there are also concerns about the Fed’s independence.

There are reports that informal advisers to Trump are proposing changes that would give him more power over the Fed, and even the idea of ​​losing central bank independence, even if unrealistic, is enough to raise risk premiums for some investors.

“After so many unthinkable events over the past few years, investors have learned that you can never say never,” said Marion Lemoredec, global head of fixed income at AXA Investment Managers.

Original title: Bond Market in Step With Fed Is About to Slam Into US Election (excerpt)

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