What’s in store for bonds in 1Q 2021 as economies reopen?
1Q 2021 bond themes and potential opportunities as economies reopen.
A tough test for global economic resilience
The fast-spreading respiratory disease is likely to severely damage global growth in the first half of 2020. In Australia, a measure of consumer sentiment3 fell 17.7% from 91.9 in March to 75.6 in April, the lowest since 1991 when Australia last experienced a recession. Unemployment4 will likely double in the second quarter from 5.1% to 10%, according to figures released by the Australian Treasury on 14 April.
Central banks have acted swiftly and are implementing aggressive policies including asset purchases and liquidity injections to offset the economic fallout and restore financial stability. Many governments have also rolled out sizeable stimulus packages to support businesses and low-income families. The Reserve Bank of Australia has pushed interest rates to as low as they will go and started down the unconventional policy path with a yield curve control policy, and measures to support small and medium-sized enterprises.
Against the current backdrop, we believe a gradual global economic recovery in late 2020 is likely. And the strength of the economic rebound will be determined by the duration of the pandemic and the effectiveness of policy stimulus.
Global growth may worsen before improving, and risk aversion could persist. In this environment, diversification1 among asset classes of varying risk profiles can play a key role in reducing portfolio volatility
The chart below shows the correlation between equities and government bonds in the US and developed economies. In most cases, the relationship is negative, which implies equity and bond prices typically move in opposite directions. This relationship underpins the principle of diversification1.
During the recent stock market sell-off, the negative correlation between equities and fixed income temporarily broke down due to a liquidity squeeze. We expect this relationship to resume once liquidity in the fixed income market normalises.
Correlations between stocks and sovereign bonds5
Past performance is not a reliable indicator of current and future results.
Targeting quality assets2,6
As investors grapple with the economic impact on consumption and manufacturing disruptions, adopting a more defensive bias in asset allocation could be optimal.
Central banks have acted swiftly, reinforcing our view that monetary authorities are focused on protecting growth while willing to tolerate inflation risks. In this regard, policy rates around the world are likely to drift lower in the medium term.
Yield generation will likely become more challenging, and price fluctuations of selected bonds are now a key concern for some investors.
Developed market government bond yields are now depressed by aggressive monetary easing while valuations in corporate credit have declined. Hence, high-quality corporate debt presents attractive opportunities as part of a fixed income allocation in these market conditions.
Deploying tactical flexibility2
Fears of the negative economic implications of the pandemic have led to a significant re-pricing across markets and asset classes. In markets like this, having the flexibility to deploy different investment tools can help build portfolio resilience. For example, some mutual funds can use futures and options strategies in a similar manner to hedge funds, seeking to take advantage of market mispricings of macro trends for potential attractive risk-adjusted return opportunities.
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Market volatility will likely persist, correlating with the number of new infections. Adopting a defensive bias in allocation and deploying tactical flexibility may help build portfolio resilience while seeking risk-adjusted return opportunities.