11 November 2021
Doves in unison
Developed market central banks have delivered dovish messaging over the past week. We analyse what this shift from previously hawkish rhetoric could mean for fixed income investors.
Central bank policy headlines have recently struck a dovish tone, focusing on projected economic data prints, notably those of the labour market. Last week’s Federal Open Markets Committee meeting successfully delivered tapering without concentrating on tightening. The tapering of net asset purchases will commence in mid-November but Federal Reserve (Fed) chairman Jerome Powell has signalled that policy rates will remain at zero until the labour market has achieved full employment, which is key following October’s jobs report. Although nonfarm payrolls rose 531,000, which was above consensus estimates, the labour force participation rate was unchanged at 61.6% as companies struggle to find workers to fill job vacancies. As such, the market does not expect the Fed to hike rates until it has had sufficient time to re-assess the landscape post quantitative easing (QE). The dovish trend appeared in other regions. The Bank of England (BoE) completed its QE envelope as expected but surprised markets by leaving policy rates unchanged, citing the undershoot in inflation to below 2% by 2024. Until labour market strength is witnessed, the BoE’s updated guidance is less aggressive than current market pricing would suggest. The Reserve Bank of Australia (RBA) formally discontinued its yield curve control (YCC) policy but it pushed back on market tightening expectations. With underlying inflation expected to reach 2.5% and wage inflation 3% by the end of 2023, the first hike is not likely to be until 2024. The European Central Bank (ECB) also gently pushed back on pre-emptive pricing of 2022 rate hikes. While ECB president Christine Lagarde has acknowledged that recent inflation surprises would last longer than previously expected, she has also stressed they would ultimately prove to be transitory.
The dovish twist in central bank messaging has spurred a reversal in yields. UK 10-year Gilts led the way over the past week, with yields falling 22 basis points (bps) to 0.86%; yields on US 10-year Treasuries fell 13 bps to 1.47% while German Bund yields dropped 12 bps to -0.29% over the same period. However, we anticipate that this brief bullishness on global yields should be short-lived and that yields should drift modestly higher into year-end. This is supported by an improving growth picture, following the trough in Q3 2021 of year-on-year (yoy) US GDP growth of 2%, which was the slowest gain of the post-pandemic recovery, as well as the removal of policy accommodation. How fast US Treasuries move higher will depend on the length of the pause between the end of tapering and the first hike. (Data as of 10 November 2021.)
An uptick in demand for duration (particularly across core rates) has supported bond prices at the long end of the curve. Investors had over-anticipated a hawkish shift by central banks and have since corrected their positioning in line with the dovish tone over the past week. Over the past months, higher government bond yields (relative to mid-year), have driven inflows from Japan, as well as increased bank holdings. Moreover, a greater proportion of pension funds in both the US and the UK are becoming fully funded, which should bolster demand for duration in the form of longer-dated corporate and government bonds as plans seek to de-risk. However, these technical tailwinds should be more than offset by the unwinding of central banks’ mammoth balance sheet holdings, as the Fed and the BoE, in particular, have cleared the way for tapering. As we pass the peak in central bank accommodation, yields should find it easier to move higher over the medium term.
An uptick in demand for bonds has been driven by Asian investors and banks
What does this mean for fixed income investors?
As key developed market central banks push back in unison on the idea that higher interest rates are imminent in order to fight inflation, we are more confident in a prolonged and orderly rise in rates following the unwinding of asset purchase programmes globally. So long as rates rise in a measured fashion, we believe short duration positioning coupled with a bias to risk assets should be monitored. Finally, we anticipate tactical opportunities across curves as the market reprices the trajectory of central bank rate hiking in tandem with economic data prints over the coming months.
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