As the U.S. presidential election approaches, investors in interest rate options are placing trades that could profit if rates stay elevated, signaling that markets may be anticipating a Republican sweep. The options market is also gearing up for potentially significant swings in U.S. Treasury yields post-election — potentially the largest in over 30 years.
A Republican win of both houses of Congress and the presidency could result in higher tariffs, which may drive up inflation and, consequently, interest rates, especially at the back end of the yield curve. Such a scenario would also likely mean an increase in U.S. Treasury debt supply to finance a substantial fiscal deficit, further lifting long-term yields.
Investors are buying long-dated payer swaptions — options that let them pay a fixed rate while receiving a floating rate — which become more valuable when interest rates remain high. Amrut Nashikkar, managing director of fixed income strategy at Barclays, observed, “The options market is behaving as if it’s expecting a higher probability of a Republican sweep. This price action is what you would expect: rates moving higher and long-end rates increasing.”
Alternatively, a Democratic victory could result in higher taxes on corporations and wealthy households, potentially slowing economic growth and leading to disinflation. In that environment, the Federal Reserve might adopt a more aggressive rate-cutting approach, likely lowering rates across the yield curve, especially on the shorter end.
Swaptions — options on interest rate swaps — are part of the massive $600 trillion rate derivatives market, where swaps reflect the cost of exchanging fixed-rate for floating-rate payments and are used to hedge interest rate risk. Payer swaptions have been especially active in longer maturities from five-year to 30-year swaps. Implied volatility, crucial in pricing these options, spiked recently as former President Donald Trump’s odds rose on betting platforms like Polymarket. On Oct. 21, implied volatility on one-month at-the-money options on 30-year swap rates hit a yearly high of 31.06 basis points, slightly easing to 30.5 bps by Friday.
Nashikkar from Barclays noted, “The long end is historically sensitive to fiscal policy because of the expected increase in Treasury issuance, which is typically higher on the long end of the curve.”