Positioning Credit Portfolios for the US Election By Investing.com

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

According to analysts at UBS, while the broader macro credit environment is expected to experience minimal disruption due to the election, micro-level impacts, particularly in specific sectors, could be more significant depending on the outcome of the election.

The US credit market is positioned for what UBS describes as a “soft landing”. This bullish outlook is supported by a strong technical backdrop and a stable fundamental mosaic.

The possibility of a Federal Reserve rate cut could bring money off the sidelines and push investors further along the credit curve, creating a favorable environment for credit portfolios.

At the same time, the resilience of the US credit cycle, highlighted by the recent increase in defaults to a significant widening of credit spreads, suggests that the market is well prepared to weather the election period without major disruptions.

“We see election-related developments having a limited impact on macro credit, but a larger one on micro credit, especially if the polls start to separate a clearer presidential winner,” UBS analysts said.

In the investment grade (IG) credit space, a win for Kamala Harris or a significant rise in poll numbers could benefit sectors such as basic industrials, capital goods and utilities.

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

On the other hand, sectors such as telecommunications, technology, banking and automotive may face headwinds in a Harris administration, primarily due to increased regulatory scrutiny and potential changes in industry dynamics, such as the accelerated adoption of electric vehicles (EV).

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

“In our proxy for a Harris win, we see autos again underperforming the above, as do aerospace/defense on a less supportive agenda for defense spending and energy on a narrower agenda for in terms of production and regulation,” UBS analysts said.

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

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

Historically, average Baa spreads have tended to tighten in the three months leading up to elections, with deadlocked results — where no party controls both the executive and legislative branches — often coinciding with a greater tightening.

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

Analysts at UBS also used implied market analysis to distinguish potential credit winners and losers based on survey variations. They noted that market reactions to changes in the probabilities of a Trump or Harris victory provided valuable insight into the sector’s performance.

During periods when Harris’ odds improved, sectors such as basic industrials, 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 in a Harris win, reflecting concerns about regulatory pressures and policy shifts away from traditional energy priorities and defense.

Finally, analysts at UBS signaled 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, technology, financials and energy.

In addition, the regulatory environment for M&A could become more stringent under a Democratic administration, particularly in leveraged finance.