MBS Live Day Ahead: Decoding Market Reaction to Election Night and Beyond

This will be a brutally simple piece of analysis.  If you'd like to see the same conclusions expressed in vastly more words, read almost anything I've written in the past few weeks. Here's a list.

At the moment (the middle of the night on election night), a Trump victory is all but assured.  Until tonight's writing on the wall, the race was close enough that we got to see exactly how markets responded to changes in the potential outcome.  

The equations were very simple.  Clinton = status quo, better for stocks, worse for bonds.  And Trump = uncertainty, better for bonds, worse for stocks.  When news would break that helped Trump's chances, bonds would rally and stocks would fall.  When news broke that put Clinton back in the lead, the trade would reverse.

Heading into election night, polling, surveys, and market-based measures heavily favored a Clinton victory.   This meant bond yields and stock prices were "too high" for a Trump victory.  Naturally then, as battleground states began going to Trump, markets had some very quick moves to make.  S&P futures were even halted briefly, due to the size of the selling.  Even now, they're down more than 100 points peak to trough.  

The highs and lows set by the current trading session in Treasuries fully eclipse the entire trading range of every day for the past month:

Fed Funds Futures have rapidly moved to their lowest rate hike probabilities in months:

If the last chart caught your eye due to the bounce in 10yr yields, you're not alone.  Overnight market movement is puzzling if you assume the election is the only market mover in town.  If Trump is winning, then bonds should just be massively improved, right?

Unfortunately for bond markets, the election is a vastly smaller concern than the other big-ticket events on the horizon.  The biggest ticket of them all is, was, and will be the European Central Bank Announcement in early December.  That's the one that might spark a European taper tantrum.  Traders couldn't care much less about which one of the two evils got elected when 100's of billions in annual bond buying is at stake.  As such, it's not a huge surprise to see bonds bounce at the pivot point consistently associated with ECB tapering risks (notice the recent bounces begin in Sep/Oct when ECB headlines were moving markets).

Bottom line: election = small potatoes.  ECB = big potatoes.  That's not to say there can't be some market volatility on the day after election day.  But don't get your hopes up for some insane bond market rally simply because bond-positive candidate won.  Trump's positive impact on bonds is not only small potatoes compared to bigger-ticket events, but it's also a strictly near-term phenomenon.  In other words, we're just dealing with the brief, initial shock of correcting trading levels to reflect reality instead of a bunch of worthless polls and surveys.