After the Republicans lost Senate control last week, the author of this commentary ponders where this leaves the US bond market.
We continue to track wealth and asset managers’ commentaries on major events and see how they expect the rest of 2021 to pan out. Clearly, the recent Georgia run-off races for the Senate, displacing Republicans from control, gives US President-elect Joe Biden more freedom to enact tax hikes and compose a fiscal expansion package. That, at least, is the prevailing view. This news service has already tracked views on these developments.
Here are comments from the UK side – giving an international take – from Nick Hayes, who is head of active fixed income allocation and total return AXA Investment Managers.
The first week of 2021 has been anything but boring. The Democrats won both Senate races in Georgia, which should allow them to pass a larger fiscal stimulus in the near term as well as pass other measures over the next two years. We witnessed shocking scenes in Washington DC, where protestors stormed the US Capitol as the Presidential election result was certified.
To deal with the violence in Washington first, this appears unlikely to have much of an impact on markets. We saw Treasury yields dip very slightly on the news, but the bottom line is that Trump has less than two weeks in office. The latest developments are concerning but analysis of them remains the preserve of political commentators.
The Democrats’ “Blue Wave” is the bigger market story here. While unexpected immediately following the 2020 Presidential election, expectations for two Democrat wins had been growing over the past couple of months. The market reaction – a small rise in Treasury yields above 1 per cent - was more important for breaking what some see as a psychological barrier, however, rather than the extent of the move itself.
For the meantime, our view on duration remains unchanged. Yields breaking above 1 per cent gives you something exciting to write about, but it doesn’t necessarily signify anything. Global investors such as Japanese pension funds are still mandated to buy safe yielding assets like Treasuries; they may come in at 1.2 per cent rather than 1 per cent, but come they will, pushing yields back down.
This might sound inconsequential, but a little bit of price volatility does help when eking out returns in bond markets. A 30 basis point move (or 0.3 per cent) might not sound like much, but that means a return of around +/-3 per cent for a bond with ten years’ duration. When you consider the other roles that government bonds can play in a portfolio - defensive protection, acting as a funding source, etc – then those returns can be meaningful.
Credit and financial debt also appealing
More broadly, certain parts of credit markets continue to look attractive with spreads at these levels. As you would expect with the potential for more fiscal stimulus, credit is currently outperforming government bonds; indeed, investors have something of a double bonus with the market continuing to be backstopped by the Federal Reserve. Given the pending appointment of Janet Yellen as Treasury Secretary, we can expect continued coordination between fiscal and monetary support.
We are considering adding to financial debt, particularly subordinated debt such as AT1s, but this is on the back of value in the market rather than any top-down macro view. This is a general point on how we manage our bond portfolios - we tend not to express macro views in individual names or sector funds, even if they might benefit from a top-down macro trend.
Not a fundamental reappraisal for duration
While the Blue Wave undoubtedly makes for a good headline, it’s not something that has taken fixed income investors by surprise. Duration still remains attractive and, in the absence of faster vaccine rollouts, it’s difficult to see that changing in the short term. The big question is whether we buy Treasuries at these levels or wait for a potential entry point of 10 or 20 basis points higher. Ultimately, however, these remain timing questions on duration, rather than a fundamental reappraisal of its attraction.