Senior Fixed Income Strategist
Summary: Tomorrow's Georgia run-offs will be incredibly important for the bond market because their result can add to the case for reflation. The 10-year Breakeven rate is the highest in two years, and the US yield curve continues to bear steepen. Eventually, 2021 could be the fifth year in more than forty years in which US Treasuries will provide a negative annual return. In Europe, an extension of lockdown measures might boost European sovereigns' sentiment as the market expects more ECB stimulus. In the UK, Wednesday BOE's governor Bailey's speech might provide an insight into the possibility of negative interest rates.
Dear readers, Happy New Year! It won't come to a surprise to know that 2021 still looks very much like 2020. The risk of running into reflation, Brexit and the Covid-19 pandemic, remain topics that cannot be ignored yet.
Starting with the US, bond investors will need to pay attention to tomorrow's Georgia run-offs to determine whether Republicans or Democrats will take control of the Senate. A Democratic Senate will enable Joe Biden to enact comprehensive legislation on the economy, healthcare and the environment as proposed during his presidential campaign. In short, it implies a bigger stimulus package that will add to the already implemented measures, putting more pressure on inflation.
Consistent with the reflation story, the market expectations on inflation are the highest in two years. The ten-year breakeven is about to touch 2%, and the yield curve continues to bear steepen.
The reflation story is crucial for bond investors because it implies that the market will not be able to find shelter in Treasuries this year as long term yields rise. Since the '70, US Treasuries' provided negative annual returns only four years (see Figure below). Although long-term yields rose since August, they are still at a historic low level providing a tiny buffer to a fall in Treasuries' prices and making them more vulnerable to just a few basis points movement in yield.
The reflation story, however, isn't stopping the primary market from issuing new bonds. Today Mexico is offering 50-year dollar bonds, and three Asian companies are issuing USD green notes. After having issued a record $3.4 trillion in corporate bonds last year, borrowers look to continue to do so at the beginning of this year to secure cheap debt before yields rise.
In Europe, the focus will continue to be on a rise of Covid-19 cases and the direct consequences of a Brexit deal.
This morning we are seeing European sovereign yields falling with the Bund benefitting the most. It is becoming clear that although the vaccination program has started, it will take months if not, even a year to get the population immunized. It suggests that an extension of existing lockdown measures is very likely.
The auction of 10-year Spanish Obligaciones this Thursday will be important to assess the market appetite for peripheral assets. Ten-year Spanish government bond yields dipped below zero in mid-December. However, they closed in positive territory by year-end amid low liquidity and news concerning a new Covid virus strain. Suppose Europe sees an extension of lockdown measures. In that case, 10-year Obligaciones yields are likely to fall back below zero as the market believes that the ECB will endlessly print money until a stable path to recovery has ensued.
This morning, despite the Brexit deal, ten-year Gilt yields trade below 0.20%, pointing to investors still thinking that the Bank of England might cut interest rates below zero. The BOE's governor Andrew Bailey's speech this Wednesday might offer insight into whether negative rates are on the agenda for the next monetary policy meeting on the 4th of February, possibly giving another push to gilts.
Economic Calendar:
Monday, January the 4th
Tuesday, January the 5th
Wednesday, January 6th
Thursday, January the 7th
Friday, January the 8th
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)
