Credit Suisse Sees Blue Sweep as Dominating Market Narrative

(Bloomberg) -- Markets are gaining confidence that the Democratic Party will win big in the upcoming U.S. election.

Despite Tuesday's partial retracement of long-end yields after President Donald Trump suspended stimulus talks, “the higher likelihood of a blue sweep scenario seems to be the more dominant narrative,” said Credit Suisse Group AG's Jonathan Cohn, referring to the prospect of victories by Joe Biden and fellow Democrats.

Positioning for a steeper yield curve, where rates on long-dated debt rise more than those on shorter-maturity Treasuries, may continue to remain in vogue as the market bets on a clean result from the November vote. The steepener trade has been a popular strategy amid the the Federal Reserve's easy monetary policy and likelihood of more fiscal stimulus.

“While we had previously looked to fade backups in rates ahead of the election -- given our expectation for fiscal stimulus discussions to remain stuck, corporate supply to taper off, and the Fed to keep conditions accommodative -- the meaningful change to the election calculus overwhelms these considerations and suggests leaning short (and toward steepening) is most prudent,” Cohn said in a note Wednesday.

On Wednesday, 10- and 30-year Treasury yields erased much of their slump that followed Trump's Tuesday tweet, by rising around 5 basis points each to 0.79% and 1.59%, respectively.

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Credit Suisse has retained its most recent election-hedge trades. One of them is a straddle, which involves buying both bullish and bearish options, targeting a selloff in Treasuries and thus higher yields across the long end of the curve. Another is a buy-and-sell strategy targeting the seven-year sector to underperform the five- and 10-year sectors.

Meanwhile, the firm has added a new trade in the form of a fairly cheap option, which targets more Fed rate hike premium than currently priced into the December 2023 part of the eurodollar market. The option has seen greater activity over the past week, based on open interest data.

Cohn's note, published before the release Wednesday of minutes of the Federal Open Market Committee's Sept. 15-16 meeting, looked at a scenario in which central bank officials might display a willingness to hike before an inflation overshoot can be realized. That's a situation which would help Credit Suisse's newly added option perform better.

The account of the Fed's meeting produced somewhat of a mixed bag: It showed policy makers disagreeing over forward guidance, but wanting to retain their flexibility to change it -- suggesting there's room to push back on the notion of keeping rates near zero until at least 2023. In addition, the minutes revealed that some policy makers want further debate on the future of the asset-purchase program, but offered nothing definitive.

The Fed is “keeping its arrows in a quiver for now,” Cohn said in an interview following the minutes' release.

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