Markets continue to be focused on further fiscal stimulus in the US and progress toward a Covid vaccine. Do these two potential risk-on catalysts signal the end of the bond bull market?
The swift and substantial monetary policy response to the pandemic shock—which included over 8,000 basis points (bps) of net rate cuts and more than USD 6 trillion of balance sheet expansion from the major economies—is largely behind us. Nevertheless, the bias for central banks remains accommodative and even towards incremental easing. Recent commentary from the Reserve Bank of Australia has firmed up expectations for a rate cut in November and potentially more quantitative easing. Meanwhile, the Reserve Bank of New Zealand is expected to take rates into negative territory in early 2021 and the Bank of England continues to flirt with a similar move, while the European Central Bank looks set to expand its bond purchase programme. In the US, the Federal Reserve (Fed) has made clear its forward rate guidance with the shift to average inflation targeting. Although the future path of the Fed’s quantitative easing programme is less evident, and it’s possible that corporate purchases will not be continued into 2021, markets will likely be reassured by the expectation that the Fed will step back in if needed. Even though most of these potential actions are largely anticipated by investors, the direction of travel for central bank policy continues to be supportive for fixed income assets.
The rally in core bonds this year has been noteworthy. Ten-year US Treasury yields started the year at 1.92% and currently stand 110 bps lower at 0.82%. German Bunds, with arguably less scope to rally given they were already in negative territory coming into 2020, have still fallen by 40 bps, to -0.59%. More recent moves in the US could look like an inflection point, with 10-year yields rising 14 bps month to date. The drivers of this move higher (potential US fiscal stimulus and vaccine progress) have the potential to push the benchmark US yield up toward 1% as they continue to play out. However, the unwavering support from central banks should limit how much government bond yields can rise, particularly at the front end of curves. (All data as of 21 October.)
Unwavering central bank support should limit how much government bond yields can rise
Despite outflows of USD 55 billion so far this month, money market funds are still up more than USD 750 billion in assets this year, creating a wall of cash looking for a home. With easy central bank policy keeping a cap on yields, the search for income persists. This was particularly evident in the strong demand for the EU issuance on 20 October—the largest order book in history at EUR 233 billion of orders for just EUR 17 billion of issuance. Strong performance on the back of the new deal has raised the question of whether the EU could supplant Germany as the eurozone benchmark in time.
What does this mean for fixed income investors?
The case for being outright bullish or bearish on core government bonds is muddied by conflicting dynamics: the potential for more fiscal spending in the US relative to the rest of the world; and progress towards a vaccine vs. rising Covid cases. Instead, a more nuanced stance on rates is warranted. For instance, the likelihood of further easing from certain central banks means we see opportunities at the front end of those markets. The long end of the US curve is likely to come under further pressure as fiscal stimulus talks progress (dependent on the outcome of the US elections), but other regions such as the European periphery offer attractive carry and stand to benefit from both European Central Bank support and the EU recovery fund backstop.
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