It is central banks driving gains in the fixed income market, not the U.S. election

It is central banks driving gains in the fixed income market, not the U.S. election

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Treasuries weren't the only beneficiaries of the volatility spurred by the U.S. election. Surprisingly, risky assets have been rallying too. U.S. junk credit spreads have tightened significantly while investment-grade spreads are lagging. We believe that investors are buying higher-yielding assets because they expect more support from the Federal Reserve. The same is happening in Europe with Gilts and BTPs tightening considerably compared to peers as investors expect more support from their respective central banks.


Investors are convinced that the market has been trading the U.S. election this week; however, there are signs that central banks have been the real protagonists.

Indeed, while uncertainties around the U.S. election's results pushed Treasuries higher, risky assets didn't lose steam even amid the second wave of coronavirus infections. We, therefore, cannot say that the sudden rise in Treasuries was dictated by risk-off sentiment.

On Wednesday, as a Biden win seemed not as evident, the U.S. yield curve started to flatten with the 10-year Treasuries leading the gains. Yields fell fast across the curve pointing to the perfect risk-off scenario, except that the S&P 500 index was rising as well. The stock market was not alone in the rally; as a matter of facts, credit spreads also tightened considerably with higher-yielding credits leading the way.

In the graph below, we look at the one week change in CDS spreads for various credit sectors. Junk bonds have been leading the gains in credit with health, utilities and energy credits being the best performers. Investment-grade credit spreads have also tightened but modestly compared to high yield spreads.

The price movement in credits shows that even if there is not a clear winner yet, investors have decided to continue to rely upon central banks.

Central banks have been expanding their balance sheet dramatically from the global financial crisis until today. As the economic crisis inflicted by the Covid-19 pandemic intensifies, they will most likely not be able to stop printing money. The outcome will inevitably be near-zero benchmark rates for longer and bigger and bigger bond-buying programmes. They can even contemplate engaging in even more unconventional policies, considering to start to buy other instruments beyond bonds. The Federal Reserve, for example, is already buying ETFs, therefore expanding to stocks would not be that far fetched.

As a consequence, this week, investors decided to put their money at work in assets that will benefit the most from central bank policies. Because junk credit spreads trade rich compared to investment grade's bonds, with the unlimited support of the FED, these are also the assets with the most significant upside. Hence, this explains the rise in junk assets prices.

To strengthen this thesis is the behaviour of European sovereigns that we have seen on Wednesday as a Biden win seemed less likely. Gilts and Italian BTPs have led the rally, and the only explanation for this is that investors were buying the ECB and those assets that will benefit the most from more accommodative policies.

Buying the central bank might be a winning strategy in Europe still; however, it might be too late to buy the FED in the United States especially when talking about Treasuries. Even though the 10-year Breakeven rate has fallen this week supporting the Treasuries' rally, another economic shock coming from the Covid-19 will most likely exacerbate an uptick of inflation. On top of it, the next President of the U.S. regardless of whom will be will need to push through congress a stimulus package. Reflation in 2021 will be real, and near-zero interest rates will be the worst thing you might hold on. In the mid-term, however, there might be scope for more upside within higher-yielding credits, as the Federal Reserve expands its bond purchasing program and tries to save the economy.

Quarterly Outlook

01 /

  • Equity outlook: The high cost of global fragmentation for US portfolios

    Quarterly Outlook

    Equity outlook: The high cost of global fragmentation for US portfolios

    Charu Chanana

    Chief Investment Strategist

  • Commodity Outlook: Commodities rally despite global uncertainty

    Quarterly Outlook

    Commodity Outlook: Commodities rally despite global uncertainty

    Ole Hansen

    Head of Commodity Strategy

  • Upending the global order at blinding speed

    Quarterly Outlook

    Upending the global order at blinding speed

    John J. Hardy

    Global Head of Macro Strategy

    We are witnessing a once-in-a-lifetime shredding of the global order. As the new order takes shape, ...
  • Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Quarterly Outlook

    Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Jacob Falkencrone

    Global Head of Investment Strategy

  • Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    Quarterly Outlook

    Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    John J. Hardy

    Global Head of Macro Strategy

  • Equity Outlook: The ride just got rougher

    Quarterly Outlook

    Equity Outlook: The ride just got rougher

    Charu Chanana

    Chief Investment Strategist

  • China Outlook: The choice between retaliation or de-escalation

    Quarterly Outlook

    China Outlook: The choice between retaliation or de-escalation

    Charu Chanana

    Chief Investment Strategist

  • Commodity Outlook: A bumpy road ahead calls for diversification

    Quarterly Outlook

    Commodity Outlook: A bumpy road ahead calls for diversification

    Ole Hansen

    Head of Commodity Strategy

  • FX outlook: Tariffs drive USD strength, until...?

    Quarterly Outlook

    FX outlook: Tariffs drive USD strength, until...?

    John J. Hardy

    Global Head of Macro Strategy

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

None of the information provided on this website constitutes an offer, solicitation, or endorsement to buy or sell any financial instrument, nor is it financial, investment, or trading advice. Saxo Capital Markets UK Ltd. (Saxo) and the Saxo Bank Group provides execution-only services, with all trades and investments based on self-directed decisions. Analysis, research, and educational content is for informational purposes only and should not be considered advice nor a recommendation. Access and use of this website is subject to: (i) the Terms of Use; (ii) the full Disclaimer; (iii) the Risk Warning; and (iv) any other notice or terms applying to Saxo’s news and research.

Saxo’s content may reflect the personal views of the author, which are subject to change without notice. Mentions of specific financial products are for illustrative purposes only and may serve to clarify financial literacy topics. Content classified as investment research is marketing material and does not meet legal requirements for independent research.

Before making any investment decisions, you should assess your own financial situation, needs, and objectives, and consider seeking independent professional advice. Saxo does not guarantee the accuracy or completeness of any information provided and assumes no liability for any errors, omissions, losses, or damages resulting from the use of this information.

Please refer to our full disclaimer for more details.

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992