Bond Bulletin

Central banks – Not so central at the moment

Bond Bulletin
Bond Bulletin
GFICC Investors

Published: 16-01-2025

The FQT research framework

Functional factors

Include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings, and leverage metrics).

Quantitative valuations

Is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors).

Technical factors

Are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum.

As the US presidential inauguration approaches, we look at how the market may react to policy actions, keeping in mind that the potential for implementing policy differs from the reality of executing it.

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Fundamentals

US economic growth remains robust and fundamental data has been effectively reflected in the market: the consumer backdrop has improved, the private sector is thriving amid looser financial conditions, and wage pressures are subsiding. The slowdown in the labour market has dissipated, which was a key reason for the Federal Reserve’s (the Fed’s) previous rate cuts. Broad-based inflation is now not too far from the Fed’s target, indicating progress towards its economic goals. The political red sweep also doesn’t necessarily equate to free rein for the new administration, with tariffs, deregulation and immigration agendas likely to continue to play a significant role. However, the uncertainty surrounding the order and scale of these policies makes it challenging to accurately predict their impacts, especially for tariffs, which can have varying effects across different regions, as China has become less dependent on the US.

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Quantitative valuations

The expectation of more expansionary US fiscal policy, along with deregulation and easier financial conditions, has led the market to reprice in order to reflect accelerated growth and inflation in the US economy. In turn, this repricing has prompted the Fed to take a more cautionary stance to monetary easing. Following last week’s non-farm payroll report, which revealed a substantial increase in job creation, US yields reached new highs, with 10-year Treasury yields up to 4.8% at the beginning of the week, from 3.6% in late September last year. With absolute yield levels at historically high levels, curves have been steepening, indicating a positive carry and roll-down, which marks a shift from the situation we observed last year. After this week’s lower-than-expected US Consumer Price Index inflation report, there was a significant rally in duration, primarily driven by improved valuations following historically high yields. In the past, there has been an inverse relationship between stock and bond returns, with higher risk leading to lower stock prices and higher bond prices. In other words, in low inflation environments, bonds have traditionally served as safe havens, providing stability in investors’ portfolios by rallying when equities sell off. However, this dynamic changes in an inflationary environment. When inflation is starting to decline, as is currently the case, the equity-bond relationship may gradually return to its traditional pattern. One scenario might be that the fixed income market reaches a point where yields rise while equity risk begins to correct, encouraging buyers to enter the fixed income market. As yields increase, the cost of borrowing rises and the discount rate used in valuing future cash flows also increases, which can make stock valuations appear more expensive and potentially less sustainable.

The window for fixed income remains open, with yields still attractive across fixed income sectors

The window for fixed income remains open, with yields still attractive across fixed income sectors

Source: Bloomberg, ICE indices. Data as of 10 January 2025. IG: Investment Grade. EMD: Emerging Market Debt. Forecasts, projections and other forward-looking statements are based upon current beliefs and expectations. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecasts, projections and other forward statements, actual events, results or performance may differ materially from those reflected or contemplated.

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Technicals

In general, investors have decreased their duration exposure. Indeed, investors appear to have reduced duration significantly according to J.P. Morgan Asset Management's recent positioning survey, which primarily focuses on US real money investors. The survey suggests that some investors have possibly even taken short positions, resulting in the market currently being generally less long. This shift in duration exposures makes owning duration appealing from a positioning standpoint, providing a potential technical tailwind.

What does this mean for fixed income investors?

With valuations appealing and the yield curve positive, now would appear an opportune time to begin gradually increasing duration by purchasing bonds further out on the curve. Rates have been rising to a point where equity risk becomes more apparent, potentially reigniting the stock-bond correlation, where a sell-off in stocks could lead to a rally in bonds. Moreover, a continuation in Fed rate cuts could be beneficial for carry strategies and the long end of the yield curve. Considering the robust state of the economy, the primary risk is that additional fiscal stimulus, such as the expansion of tax cuts, might be introduced when it’s not necessary, potentially causing a resurgence in inflation. With a significant amount of money already circulating in the system, any further stimulus that triggers a growth and inflation shock could lead to a subsequent Fed rate hiking cycle, for which markets are largely unprepared. On the other hand, healthy growth, along with a rebalancing labour market and slowing inflation, might enable the Fed to maintain a gradual easing bias. However, while the market appears to be anticipating swift policy enactment by the new US administration, it is important to be aware that policy changes may take some time to be implemented.

About the Bond Bulletin

Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.

Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.



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GFICC Investors

Published: 16-01-2025

The FQT research framework

Functional factors

Include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings, and leverage metrics).

Quantitative valuations

Is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors).

Technical factors

Are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum.