Fundamentals

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.

Quantitative valuations

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

Source: Bloomberg; data as of 21 October 2020.

Technicals

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.