Midterms and the rates trade: will bonds move first?

Bond yields aren't waiting for election night

The bond market is already moving. The 10-year Treasury yield pushed above 5% in mid-September, its first move past that level since 2023, and touched 5.34% in early October, its highest in 24 years, as rising oil prices and inflation worries sparked a sell-off. The administration has been looking to bring borrowing costs down ahead of the vote, and the Treasury has stepped up its buybacks of longer-term debt, doubling the maximum size of its operations in the 10- to 30-year sector from $2 billion to at least $4 billion. Yields have stayed elevated regardless, with the 10-year at 5.24% on 9 October, and markets are pricing a meaningful chance of a further Federal Reserve (Fed) rate increase after September’s hike.

That makes rates the first place to look for any election-related repricing.

Why deficits are the name of the game

A divided Congress could limit new spending. A unified one might find it easier to extend tax cuts or add fiscal support. Either way, the bond market’s question is the same: how much debt needs to be absorbed and at what price?

That’s why the volume of new government debt being sold to investors is a real risk. If there is a lot of debt on offer and not enough buyers, the government has to offer higher yields to attract them. Whatever the political story, yields can jump quickly.

History hints at some possible relief. Over the years, 10-year yields have tended to rise in the first half of a midterm year and ease in the second. But that’s a pattern, not a promise. The 10-year rose sharply in the third quarter, and this year’s inflation and oil dynamics could override it.

Where a rates move could travel

Here’s how a shift in yields could ripple through the market:

• Treasuries and the US dollar – a double-edged draw: Higher yields tend to attract foreign investors, which could support the dollar. The Dollar Index rose around 2% in September as yields climbed. But the picture isn’t always that simple. If deficits look set to grow, yields could rise as investors worry about the extra debt, and the dollar could slip on worries about US finances.
• Banks – bigger margins, bruised balance sheets: When long-term rates rise faster than short-term ones, banks can earn more on lending. But fast-rising yields chip away at the value of the bonds banks hold. Economists have flagged risks to small and medium-sized banks when the 10-year yield is above 5%, a level it has now crossed.
• Growth stocks – most exposed to the discount rate: Technology and other long-duration shares are the most sensitive to discount rates, because their earnings sit further in the future. Rising yields can squeeze valuations even when earnings are on track.
• Gold – caught between hedge and opportunity cost: Gold is caught between its role as an inflation hedge and the opportunity cost of holding an asset that pays no yield. It slid as yields surged, then recovered modestly after softer inflation data eased rate-hike expectations, though high yields have capped the rebound. Real yields and the dollar are the ones to watch.
• Housing-sensitive stocks – the front line of rate stress: Mortgage rates follow the 10-year yield, which makes homebuilders, building suppliers and mortgage lenders natural barometers of rate stress. The 10-year is the benchmark for mortgages, car loans and corporate borrowing, and mortgage rates have moved back towards 7%, so a sustained rise feeds straight into affordability, a theme both parties are watching.

What traders may want to watch

Here’s your checklist for the weeks ahead:

• Treasury auctions: Strong or weak demand for new government debt shows how much pressure yields may be under.
• The 5.34% peak: Investors asked whether 5% would act as a ceiling, as it did in 2023, but the 10-year has now traded above it for weeks. The question is whether the early-October high holds or whether long-term rates are settling into a higher range.
• Inflation and Fed pricing: September CPI is due on 14 October and the Fed decides on 28 October. The consumer price index (CPI) and the Fed’s tone will shape how much room policymakers have.
• Post-election fiscal signals: Early comments on spending, tax measures and the debt ceiling could move yields more than the result itself.
• Cross-asset moves: If the dollar, gold and bank shares all react to yields in the same direction, rates are likely setting the pace for the broader market.

The takeaway

Election outcomes are uncertain, and no single result is guaranteed to move markets in a particular direction. What's clearer is how the chain works: fiscal expectations feed into yields, yields into the dollar, and from there into banks, growth shares, gold and housing-linked stocks.

If the midterms do move markets, the bond market may be the first to say so. Stay tuned, this one could get interesting!