Bond Bulletin
18-09-2020
GFICC Investors
Risks on the horizon
Coming out of our most recent investment quarterly meeting, we acknowledge that the growth rebound has been extremely strong. With some key risks to markets ahead, we expect the pace of growth to be slower, albeit still positive, in the next three-to-six months.
Fundamentals
The first key risk for the months ahead is, of course, the virus. As things stand, cases have risen in multiple regions, but hospitalisation and mortality rates remain low, meaning we are not seeing the national lockdown measures that shut down economies in Q1. Positive vaccine news is also expected in the near term, and should support sentiment as and when it is delivered. On the other hand, a sharp rise in mortality, or a downside surprise on the vaccine front, could pose a serious threat to growth. The second significant risk is the US election. With various outcomes possible, and with polls appearing to tighten, there is the potential for heightened volatility as we approach November. An inconclusive result is one of several outcomes that could result in faltering growth. Finally, and related to the election outcome, another risk is the direction of fiscal policy, particularly in the US. Currently, US households appear resilient, as shown by disposable income levels – but this resilience is due in large part to fiscal measures, which look set to fade by November. A lack of further fiscal support, or a significant delay, could hold back the consumer and have a negative impact on growth. Balancing these risks is the extreme accommodation being provided by central banks, which is unlikely to be withdrawn anytime soon.
Disposable income looks set to fall without further fiscal stimulus
Source: J.P. Morgan Chase Card; data as of 31 August 2020. Projections shown beyond August 2020, assuming constant average Q3 outflow pace, August unemployment benefits and other inflows.
Quantitative valuations
In this context of continued growth and loose monetary policy, spreads and core yields have rallied globally. The yield on the 10-year US Treasury has remained in a tight range since April, and has traded between 0.63% and 0.75% since 8 August. This is likely to persist – and even in the event of an early positive vaccine surprise, we do not expect yields to rise far above 1%. Spreads are also tight across risk assets, having retraced substantially over the past two quarters. This means investors need to look more carefully at niche sectors to find yield. One sector that may present opportunities is investment grade hybrids, where spreads remain around 100 basis points higher than their one-year tights.
Technicals
We expect strong demand across markets to be a consistent feature of the coming months, whether it comes from central banks or from investors on the continued search for yield. The supply backdrop could vary more by market: in some sectors, such as high yield, higher supply could weigh on the market (perhaps providing buying opportunities), whereas lower supply forecasts elsewhere (US investment grade, for example, where we expect net supply to drop by USD 200 billion in Q4) should continue to provide a tailwind for spreads.
What does this mean for fixed income investors?
Our base case remains that we will see above-trend growth over the coming months, but that the pace will be slower, and dependent on key events. A negative surprise on the virus front would shake confidence across the real economy and financial markets – as would a shock or a contested result in the US presidential election. Monetary policy remains sufficiently accommodative to counter this, but the fiscal response – so crucial in the last two quarters – will need to be monitored very closely. Barring negative outcomes, low core rates should perpetuate the grab for yield and support demand for risk assets.
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
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