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Less than two weeks after it recommended that advisors include fewer bonds in client portfolios, BlackRock has downgraded nominal U.S. Treasurys to an underweight, and upgraded Treasury inflation-protected securities (TIPS) due to the growing odds of a Democratic sweep.

Such an election outcome may lead to a “significant fiscal expansion” along with higher inflation, putting upward pressure on interest rates, according to BlackRock Investment Institute strategists led by Mike Pyle, its global chief investment strategist. 

(Related: Here’s How Advisors Should Position Portfolios Now: BlackRock)

The Fed’s new monetary policy framework allowing inflation to temporarily top its 2% target may work to constrain its “ability to lean against inflation,” according to the strategists’ weekly commentary report.

Long-term interest rates had been rising over the past week in line with growing expectations that Democrats will win the presidency and the Senate, and that Democrats and Republicans would reach agreement on another economic aid package. But hopes for another stimulus package evaporated on Monday, and its demise, along with rising rates of COVID-19 infections, sent the 10-year Treasury yield down to 0.80% from an intraday high of 0.85% on Friday.

COVID-19 infections in the U.S. set a new daily record on Friday of 85,000 and a record seven-day average of about 68,767 new cases on Monday.

BlackRock strategists don’t expect that the current resurgence of COVID-19 cases will lead to as deep of an economic decline as the one that followed the first wave of the pandemic, but they caution that the “activity restart” of the U.S. economy is “moving into a more difficult phase” as infection flare-ups prompt tighter restrictions. “We see the hardest part lying ahead.”

While the strategists downgraded U.S. Treasurys, they upgraded German bunds to neutral, and are currently overweight euro-area peripheral government bonds due to stepped up quantitative easing by the ECB along with other policy actions. They expect the ECB will announce further monetary easing before the year-end.

BlackRock is also overweight European equities due to cyclical restarts of economies against the backdrop of solid public health measures and other policy responses to the pandemic, and is  overweight global high yield — “an attractive source of income in a yield-starved world.”

The strategists are neutral on U.S. and Japanese equities, and underweight emerging market equities and hard currency-denominated emerging market debt because of the pandemic’s spread and limited policy responses in some emerging economies.

— Check out Goldman: Democratic Sweep Would Be a Plus for U.S. Economy on ThinkAdvisor.