How this week's election results can impact the bond market — and interest rates

Democrats won significant majorities in both the House and Senate on Election Day. While the final tallies in both chambers of Congress won’t be clear for awhile, it’s clear that the U.S. is headed into a period of a divided government.

A Republican still helms the White House. While Democrats will be in charge of Congress come January, they don’t have a large enough majority to override presidential vetoes. That dynamic could have big implications for the bond market and consumer interest rates.

One of the reasons yields on Treasury bonds have risen in recent months is because the federal government has racked up so much debt. Over $40 trillion.

That means the government has to issue more bonds, and bond investors’ demand for them is not as strong as it used to be, said Peter Conti-Brown, professor of financial regulation at The Wharton School.

“That demand has become more satiated, and so we've got more investors who are starting to charge more of a premium, especially on the longer-duration issuances,” he said.

There is a chance that the incoming divided government could lower bond yields. It’ll be harder for a Democratic Congress to get the president’s signature on big spending bills, and harder for the president to pass big tax cuts.

“There's potential for more fiscal constraint going forward because of the divided government side of things,” said Cooper Howard, director of fixed income strategy at Charles Schwab, which is a Marketplace underwriter.

That could mean the federal government takes on a bit less debt and doesn’t need to issue as many bonds, so bond yields tick down.

Lower government bond yields matter to consumers and businesses, said Campbell Harvey, a finance professor at Duke’s Fuqua School of Business.

He said when Treasury yields go up, “it usually triggers an increase in yields that that corporations get for their bonds, consumer loans, and importantly, mortgages.”

The bond market could also get some relief from the new Congress because Democrats will now have more influence over President Trump’s appointments to the Federal Reserve, Harvey said.

“The chance of one particular party capturing the Federal Reserve has decreased given the election,” he said. And an independent Fed is less likely to make decisions that could drive up inflation and bond yields.

But there is also a risk the new dynamic in Washington could roil the bond market. Congress and the president will have to agree on funding the government, and if they don’t, the government could shut down.

“A long drawn out shutdown could push us over the biggest of cliffs, which is default,” said Conti-Brown at Wharton.

That scenario is unlikely. But even just the possibility of the federal government defaulting on its debt payments could send bond yields up.