Active Minds – Bond market wobbles over election, Fed direction
Active Minds – Bond market wobbles over election, Fed direction
Mark Nash looks at choppy bond markets in the first trading days of the year, and explains why he believes the Fed cannot sit back and let the market set rates.
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Bond market wobbles over election, Fed direction
The choppy markets in the first trading days of the year suggest that 2021 may be bumpier than many investors had envisioned, said Mark Nash, Fund Manager, Fixed Income.
The surprise Georgia election result gave Democrats control of the Congress and will mean more US fiscal spending but may also bring reduced monetary support from the Federal Reserve (Fed), Mark said. The bond market has been spooked by Fed officials’ recent comments about eventually dialling back quantitative easing (QE), and Mark noted that it is far too soon for that given the weakness of the US economy.
The potential for more Treasury bond issuance with less Fed purchasing has pushed up global yields, steepened the yield curve and triggered volatility in trades in emerging markets and gold. It could eventually push up real interest rates and tighten financial conditions, which is why in Mark’s view the Fed should not think it can sit back and let the market set rates.
Higher fiscal spending will be supportive of reflation, but Mark believes the market’s hopes of QE forever, ample liquidity, central bank yield curve control and a good environment for risk assets looks less certain.
The surprise Georgia election result gave Democrats control of the Congress and will mean more US fiscal spending but may also bring reduced monetary support from the Federal Reserve (Fed), Mark said. The bond market has been spooked by Fed officials’ recent comments about eventually dialling back quantitative easing (QE), and Mark noted that it is far too soon for that given the weakness of the US economy.
The potential for more Treasury bond issuance with less Fed purchasing has pushed up global yields, steepened the yield curve and triggered volatility in trades in emerging markets and gold. It could eventually push up real interest rates and tighten financial conditions, which is why in Mark’s view the Fed should not think it can sit back and let the market set rates.
Higher fiscal spending will be supportive of reflation, but Mark believes the market’s hopes of QE forever, ample liquidity, central bank yield curve control and a good environment for risk assets looks less certain.
EM set to benefit from more predictable US policymaking
Emerging market (EM) equities performed particularly well last year, noted Liz Gifford, Fund Manager, Global Emerging Markets. The MSCI Emerging Markets Index closed 2020 up over 18%, despite having fallen more than 30% in the February to March sell-off (in US dollars). Given the challenges of 2020, that was an unforeseen outcome, and one that investors will have gladly welcomed.
It’s been an interesting start to 2021 too, said Liz. In the US, we have seen further developments regarding Chinese corporates. The US had already added to a US investor blacklist over 30 Chinese companies suspected of having links to the Chinese military, meaning that US investors must divest any investments they hold in these companies. The executive order came into effect earlier this week, and investors have until November to fully sell out of their investments. More companies, their subsidiaries and multiple listings of the stocks are now being added to the list. Last week, the US government also put pressure on the NYSE to remove the American Depositary Receipts (ADRs) of three Chinese telecoms companies – after a couple of U-turns, the de-listings are now going ahead.
In retaliation, China has prohibited companies and individual investors from complying with foreign sanctions that ban transactions with Chinese companies and individuals, with immediate effect. Companies that believe they have been targeted by sanctions can appeal to the commerce industry and will receive financial support.
With Biden taking office on 20 January, Liz and the team are hopeful that we will see more traditional and predictable policymaking in the US. They remain excited about the outlook this year for emerging markets – there have been strong inflows into the asset class over the past few months, and overall exposure remains low among global managers.
It’s been an interesting start to 2021 too, said Liz. In the US, we have seen further developments regarding Chinese corporates. The US had already added to a US investor blacklist over 30 Chinese companies suspected of having links to the Chinese military, meaning that US investors must divest any investments they hold in these companies. The executive order came into effect earlier this week, and investors have until November to fully sell out of their investments. More companies, their subsidiaries and multiple listings of the stocks are now being added to the list. Last week, the US government also put pressure on the NYSE to remove the American Depositary Receipts (ADRs) of three Chinese telecoms companies – after a couple of U-turns, the de-listings are now going ahead.
In retaliation, China has prohibited companies and individual investors from complying with foreign sanctions that ban transactions with Chinese companies and individuals, with immediate effect. Companies that believe they have been targeted by sanctions can appeal to the commerce industry and will receive financial support.
With Biden taking office on 20 January, Liz and the team are hopeful that we will see more traditional and predictable policymaking in the US. They remain excited about the outlook this year for emerging markets – there have been strong inflows into the asset class over the past few months, and overall exposure remains low among global managers.
Credit market euphoria is a reason to be cautious
The Senate election result in Georgia was very significant for US Treasuries and the dollar, said Adam Darling, Fund Manager, Fixed Income. It represented a big change in the market environment, breaking the ‘goldilocks’ narrative that a split Congress would hamstring Biden’s more ambitious stimulus ideas, keep the Fed printing money, and generally lead to continued accommodative conditions. Instead, we have a situation where Biden is able to do a lot more from a fiscal perspective and that has implications not just in the US but globally.
In a lot of other rates markets across the world, yields are still in line with, or lower, than where they were in November. Despite all this focus on US Treasury yields appearing to break out, said Adam, if you look at gilts, bunds or JGBs there hasn’t been an equivalent move. That’s interesting to Adam because shows how comfortable investors are with the concept of yield curve control in those markets, and that irrespective or economic data we won’t see nominal yields moving.
Finally, it could simply be the case that markets lack the confidence to price in a happier future at the moment, given how dire the Covid situation remains in the US and Europe in particular. 2021 will tell us a lot, said Adam, because governments are borrowing an enormous amount of money, and the assumption was that it would all be monetised and there wouldn’t have an impact on interest rates. Yet the Fed has already started rumbling about maybe being less aggressive in buying bonds, and any indication that markets will have to fund these deficits more than expected could cause volatility.
Against that backdrop, there is almost euphoria in the credit market, with investment grade spreads now tighter than they were in early 2020 before the pandemic. It’s amazing to Adam that credit is more expensive today, when we’re still in the midst of the worst pandemic since the Spanish Flu, and he puts that down to the central banks and investor confidence that credit has become a policy tool for central banks. If you’re buying bonds at prevailing spreads today, said Adam, you need to fully buy into the narrative that – regardless of economic fundamentals – there is limited sell-off risk in credit spreads because central banks have your back. To Adam that is a sign that it is time to invest cautiously.
In a lot of other rates markets across the world, yields are still in line with, or lower, than where they were in November. Despite all this focus on US Treasury yields appearing to break out, said Adam, if you look at gilts, bunds or JGBs there hasn’t been an equivalent move. That’s interesting to Adam because shows how comfortable investors are with the concept of yield curve control in those markets, and that irrespective or economic data we won’t see nominal yields moving.
Finally, it could simply be the case that markets lack the confidence to price in a happier future at the moment, given how dire the Covid situation remains in the US and Europe in particular. 2021 will tell us a lot, said Adam, because governments are borrowing an enormous amount of money, and the assumption was that it would all be monetised and there wouldn’t have an impact on interest rates. Yet the Fed has already started rumbling about maybe being less aggressive in buying bonds, and any indication that markets will have to fund these deficits more than expected could cause volatility.
Against that backdrop, there is almost euphoria in the credit market, with investment grade spreads now tighter than they were in early 2020 before the pandemic. It’s amazing to Adam that credit is more expensive today, when we’re still in the midst of the worst pandemic since the Spanish Flu, and he puts that down to the central banks and investor confidence that credit has become a policy tool for central banks. If you’re buying bonds at prevailing spreads today, said Adam, you need to fully buy into the narrative that – regardless of economic fundamentals – there is limited sell-off risk in credit spreads because central banks have your back. To Adam that is a sign that it is time to invest cautiously.
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