5 August 2021
As we move through the quieter summer months, we take a look at recent economic data and try to make sense of Treasury markets after another week grinding lower in yield.
The past couple of months have presented challenges to the pro-growth outlook and the reflation narrative. Purchasing managers’ indices (PMIs) have peaked, with the July Institute for Supply Management (ISM) manufacturing index surprising to the downside at 59.5, and global PMIs edging downwards. As such, supply bottlenecks – a key driver of higher inflation earlier in the year – appear to be subsiding, as indicated by lower supplier delivery times. These data points come at a time when the Delta variant continues to spread, particularly in China, which could have obvious ramifications for global growth. However, judging by absolute levels, the economic backdrop remains resilient, which makes recent rate moves challenging to justify. PMIs at almost 60 indicate strong expansionary dynamics, and growth remains strong, with consumption remaining the key driver of the 6.5% second-quarter US GDP print. Furthermore, while a key risk to monitor, it is not yet clear that the Delta variant will lead to broad-based lockdowns as previously experienced.
Lower manufacturing activity and an easing of supply bottlenecks suggests lower growth, but absolute levels signify strength
The Treasury rally has continued into August: having returned 2.35% in July, the month-to-date return on US 10-year debt has been 0.38%, as rates continued to fall. Current levels, around 1.18%, are now 56 basis points (bps) lower than the 1.74% peak at the end of March. It should be noted, though, that the recent leg lower in rates (12bps in August) does not represent a flight to safe havens: risk assets are also up in price, with European high yield returning 0.22%, emerging market sovereigns returning 0.39% and equities (as represented by the MSCI World index) up 0.54%. Furthermore, gold – the performance of which typically has a positive correlation with bond prices – has returned -1.33% in recent days, which suggests a risk-on rally is underway.
Typically, July and August tend to be better months for government bonds as the supply of government debt dries up going into the summer period. This year is no exception, but there have been additional factors pulling yields lower. The sheer weight of money in circulation is the overarching driving factor, as the Federal Reserve (the Fed) continues to buy more than USD 40 billion of Treasuries on a monthly basis. With tapering yet to be announced (and unlikely to commence until next year), this is a factor that can’t be ignored. Moreover, fiscal policy has led to a build-up of cash in household accounts, and with banks flush with deposits and in no rush to lend to corporates, part of this money has likely made its way into Treasury markets. If the drivers of lower rates have been largely technical, we think the catalysts for a reversal are also technical. September should bring higher supply, especially if we see progress made on further fiscal stimulus, and the scene could be set for higher rates if the Fed does announce tapering in the fourth quarter.
What does this mean for fixed income investors?
The post-peak growth environment still looks robust by any measure. Although the Delta variant presents a key risk to economies with less effective vaccines, the move lower in rates, on balance, still appears to be technically driven. The typical summer slowdown is likely to delay any significant catalysts for a reversal, but as the fourth quarter draws closer, supply picks up in September and the Fed inches closer to announcing some kind of tapering, some of these technical tailwinds to government bonds could start to subside.
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