What’s in store for bonds in 1Q 2021 as economies reopen?
1Q 2021 bond themes and potential opportunities as economies reopen.
Every quarter, our GFICC senior investors gather to formulate a consensus view on the near-term fixed income markets. The result of this is a strategy roadmap for the coming three to six months.
Above Trend Growth remains our base case for 2Q 2021, raised to 90%1 with continued accommodative monetary and fiscal policies in place, vaccinations accelerating and our 2021 US real gross domestic product (GDP) forecast raised to a 38-year high1. Despite potential for a pickup in inflation, structural headwinds are likely to keep interest rates and inflation in check.
Sub Trend Growth was reduced from 15% to 0%1. We believe any concerns with vaccine rollouts or a virus variant are absorbed more readily than last year. Corporations will continue to repair their balance sheets and fiscal policy response is muted and reactive.
The likelihood of a Recession and Crisis remain 5%,1 respectively. The only known unknown is whether a variant of the virus would trigger a meaningful setback to the reopening of the global economy.
GFICC Scenario Probabilities and Investment Expectations: 2Q 20214
Central banks are likely to keep their word
We believe central banks are likely to keep their word and not raise rates until around the end of 2023, and expect the US Federal Reserve (Fed) to control the normalisation of 10-year Treasury yields toward 0% real yield. A range of 1.875%–2.125% would be palatable to bond investors if this is stretched out over the next few quarters.
Stronger reopening growth, a weaker US dollar and higher commodity prices have also boosted the inflation outlook. The growth handoff from goods to services should become visible in inflation, with some services’ prices mirroring the surge in goods prices, amid the global public health crisis.
On inflation risk, we expect prices to rise more than 2% year-over-year - potentially higher, depending on consumer spending and a US infrastructure spending bill - but we believe the structural factors that have dampened inflation for years will likely remain.
Long-term inflation expectations are still muted5
Optimising opportunities in current market conditions
Inflation has moved to the front of the queue of potential risks. But our GFICC team believes major central banks are likely to stay true to their word and keep policy accommodative for the foreseeable future. This could essentially weather the short-term inflation storm. Structural headwinds are likely to keep interest rates and inflation in check1.