2 July 2021
Vaccinations vs. containment
With the Covid-19 Delta variant now global, we compare the tail risks associated between countries focusing on containment versus vaccine distribution.
With the Covid-19 Delta variant now widespread, fundamentals remain mixed across regions. In the UK, daily new confirmed Covid-19 cases have increased rapidly; the most recent data shows over 16,000 confirmed cases over a rolling seven-day average, versus just over 3,000 at the end of May. Although far from the January 2021 peak of close to 60,000 daily confirmed cases, we are clearly in the midst of another wave – though potentially a less lethal one. Daily confirmed Covid-19 deaths per million people remain low in the UK at 0.26 over a seven-day rolling average versus the peak of 18.46 in January 2021. Furthermore, although the numbers of weekly hospital admissions and ICU patients have risen slightly, they remain low. Where containment and lockdowns were successful in the early and middle stages of the pandemic, vaccinations are now breaking the link between case counts and mortality rates. In fact, a recent study done by Public Heath England found that the Pfizer-BioNTech and Oxford-AstraZeneca vaccines were respectively 96% and 92% effective against hospitalisation after two doses. While the US and the UK have run successful vaccination programs and now have close to 50% of their populations fully vaccinated, others countries are lagging; Australia has fully vaccinated just over 5% of its population. As central banks start to think about normalisation, the Covid-19 Delta variant may be a tail risk for countries with low vaccination rates and may make it difficult for those central banks to start tightening policy. (Source: Our World in Data. Data as of 28 June 2021.)
Covid-19 Delta variant could pose tail risks for countries with low vaccination rates
Swift vaccine distribution and subsequent reopening efforts have provided strong tailwinds for global economic growth, driving core government bond yields higher. Although central banks have started discussing policy normalisation, the spread of the Delta variant could be a strong headwind to push out any rate hikes – especially in countries with lacklustre vaccination programs. Currently the market is pricing in one and a half rate hikes in 2022 for Australia, although the Reserve Bank of Australia (RBA) has stated no hikes until 2024. The RBA could update their views and move rate hikes forward because of recent strong data prints, but this is likely to be challenging when low vaccination rates and the spread of the Delta variant in Australia have forced almost half of the population back into lockdown. Strong vaccination programs in the UK, the US and Canada provide more supportive growth backdrops and affirm market pricing. We expect that interest rates are more likely to rise in those countries with higher vaccination rates, where central banks are able to normalise policy.
Positioning has cleaned up across core rates and curves with divergent positioning appearing to be aligned with the containment vs. vaccination narrative. Investor positioning remains underweight in the US, the UK, Germany and Canada, and overweight in Japan and Australia, where the vaccination rates are low. In the US, the Federal Reserve’s recent hawkish shift has made the front end of the yield curve more sensitive to data prints. Our bias remains for higher yields with the US 10-year nearing 2% by the end of the year. However, we are conscious that a move higher in yields could be difficult for countries with low vaccination rates who are moving back into lockdowns.
What does this mean for fixed income investors?
Vaccinations have broken the link between case counts and mortality rates, but investors need to consider the tail risks associated with the spread of the Covid-19 Delta variant, especially in countries where vaccination rates remain low. Further lockdowns in regions focusing on containment may push back any hawkish messaging from central banks and keep a cap on government bond yields. Within portfolios we are less exposed to duration and more exposed to currencies where the policy environment is moving towards normalisation.
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