29 July 2021
Post-peak growth
Fixed income fundamentals remain healthy, supported by strong economic data, central bank policies and evidence that vaccines may allow economies to avoid fresh lockdowns. The recent rally in rates may have created opportunities in high yield.
Fundamentals
Although global growth momentum has likely peaked in the first quarter, strong economic data, policy support and successful vaccine distribution continue to drive fundamentals. In the US, June consumer price index (CPI) growth of 0.9% month over month was the third turbo-charged print in a row and US retail sales remained strong, rising 0.6% in June compared to the previous month. In Europe, the European Central Bank (ECB) delivered a dovish change to forward guidance following its policy meeting last week. The ECB affirmed that rates will remain at current or lower levels until it sees inflation reaching 2%, well ahead of the end of its projection horizon. A dovish ECB, combined with recent eurozone macro survey releases surprising on the upside, provides strong fundamentals for the eurozone. Finally, on the Covid front, it appears that vaccinations have weakened the link between cases and hospitalisations, which could limit any further material mobility restrictions. In the UK, case counts seem to have to peaked and hospitalisations remain low—a fifth of what they would be, as predicted by previous data. Taking a step back from the recent volatility in the rates market, global growth data remains robust for the rest of the year. Although some recent growth forecasts have been revised down, we see it as an adjustment rather than having run over.
Vaccines seem to have weakened the link between case counts and hospitalisations
Source: Our World in Data. Data as of 27 July 2021.peak’
Quantitative valuations
US Treasury yields have fallen off track over the past couple of months with the US 10-year reaching a low of 1.19% on 19 July. As discussed in last week’s bulletin, we see the rally being primarily driven by the weight of consistent bond buying from both central banks and the private sector. Although this has been a pain for the consensus shorts in the market, it may have created an opportunity in high yield. European and US high yield spreads have widened over the month by 13 basis points (bps) and 22 bps, respectively. This recent widening has made valuations more attractive for risk assets. With current yield to maturity (YTM) at 2.85% and 4.62% for European and US high yield, respectively, this looks attractive from a carry perspective.
Technicals
Supply and demand dynamics have been a strong technical driver in recent months. The recent rates rally, in part due to seasonality, has been further exacerbated by the continued quantitative easing (QE) bond buying by central banks and strong demand from the private sector. Positioning surveys continue to point towards consensus shorts in the market; while we are continuing to monitor this, the additional corporate and European government supply that’s expected could provide an opportunity to add risk on the back of any spread widening. In the near term, however, high yield supply in August is expected to be low in the US (USD 25 billion) and even lower in Europe (EUR 2 billion), which could provide a potential tailwind for yields to grind tighter before the September pickup in supply.
What does this mean for fixed income investors?
Despite growth momentum peaking in the first quarter, global growth remains robust. Strong global data prints and easy monetary policy continue to provide a tailwind for economic growth. Furthermore, despite the risks of the Delta variant, it is clear that vaccinations have now weakened the link between case counts and hospitalisations enough to avoid further mobility restrictions. Although the recent rates rally has been difficult on the consensus shorts in the market, spread widening within high yield has made for more attractive valuations in the near term.
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.
Fundamental 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