Sovereign debt bubble poses threats amid US election and rising inflation

Sovereign debt bubble poses threats amid US election and rising inflation

Althea Spinozzi
Head of Fixed Income Strategy
Central banks worldwide are increasing their accommodative measures, in the form of quantitative easing and helicopter money, to resolve deep economic problems. To date, this has contributed to high stock markets and low interest rates both in Europe and in the United States. Even though an investor might have benefitted from the bullish market this year as the coronavirus pandemic was losing steam, there will be a reckoning.

The reckoning is going to stem from the US election and inflation, and bonds will be the first assets to suffer from it. Now more than ever, it is crucial to think about portfolio allocation and inflation hedges, to defend capital while we are witnessing to a debasement of fiat currencies.

Sovereigns – a pressure cooker about to explode 

Because near-zero interest rates don't give any protection against rising inflation, sovereigns are the worst assets you can hold in your portfolio right now. Buying government bonds today means locking in such a low yield that, if inflation rises, the bond’s value will fall. It won't help to hold the bond until maturity, because inflation will eat up the small coupon that one is receiving together with the principal.

At the same time, government bond volatility worldwide is at its lowest point in history. This makes these securities even harder to trade – because in order to benefit from a one-basis-point shift, one needs to leverage their position massively.

We believe that US Treasuries today are the biggest mousetrap of all time. They do not provide any long-term upside, and the yield curve is doomed to steepen faster than expected due to inflation.  Within the context of the US election, however, there might be space for short-term trading opportunities. We anticipate a bull-flattener US yield curve if Biden wins, and a bear-steepener if Trump wins.

We are quite solemn about inflation. There is so much focus on reviving it that at a certain point, it will rise. And when it is on the rise, it will be unstoppable because monetary policy will be the only tool to slow it down. Central banks cannot count on fiscal policy, because it is political.

What is happening now is that the US government is putting money directly in the pockets of families to avoid a blown-out crisis amid the coronavirus pandemic. Families that need money spend money as they receive it. Thus, inflationary pressure increases. If inflation is suddenly on the rise, what can the next US President do? He can’t take the money that has been given to families back, because this would make him extremely unpopular. So helicopter money will stay, inflation will continue to rise, and the Fed alone will be trying to stop it.
Even though there is a chance inflation will remain subdued in the last quarter of the year, we have to consider that volatility might rise amid a second wave of Covid-19, which may affect sovereigns’ performance. While the coronavirus pandemic has been beneficial to US Treasuries and the Bund, the yields of riskier sovereigns jumped significantly. The most remarkable example is Italy, which at the moment is offering the lowest yield it has ever paid since joining the euro. Before coronavirus, the 10-year BTPs were offering around 1% in yield. At the peak of the pandemic, they were offering close to 2.5%.

Italian sovereigns are perceived as a risky asset by the market, so whenever there are troubles, investors sell BTPs and buy the Bund. Now that Italian BTPs have tightened to pre-pandemic levels, we believe that there is more downside in holding these securities than upside. When trading, it is crucial to understand when to take profit and when to take a loss. Now that the market is high, it is time to sell in order to reposition for what's to come. We believe this is especially true for sovereigns from the European periphery: Spain, Italy, Portugal and Greece.
Credit deterioration means downgrades and defaults are on the way

Since the 2008 financial crisis we have seen central banks all around the globe trying to contain market volatility. Unconventional tools have been implemented to guarantee both liquidity and favourable economic conditions. None of these policies succeeded in treating a sick economy. With the advent of the coronavirus pandemic, central banks that were hoping to tighten the economy instead had to stimulate it even further.

Over the course of the last decade, more and more corporates have been taking advantage of the economic situation by gearing up their balance sheet. Financing is getting cheaper and cheaper, and investors are getting more and more attracted to risk. As credit deteriorates worldwide, this behaviour will have severe consequences in the corporate space. We believe that a second wave of coronavirus pandemic and the US election could be the triggers for a large number of corporate downgrades and defaults. This is the reason why we recommend investors to be cautious and cherry-pick risk as we enter the latest quarter of the year.
US election: predicting US corporate bond performance in the last quarter of the year

Trump wins
We can expect a copy and paste of what we have seen in the past four years: deregulation, lower corporate taxes and a focus on domestic production. In this context, we favour financials, infrastructure, energy and domestic industrials and manufacturers. Junk bonds have a higher upside potential. However, even though we don't mind lower-rated bonds, we still prefer mid-term maturities up to seven years to limit inflation headwinds.

Biden wins
The market will perceive a Biden win as a credit negative. We expect weakness in the sectors that have benefitted from deregulation and low corporate taxes under the Trump administration. In this scenario, we prefer higher-quality bonds to take advantage of short-term volatility that will induce investors to fly to safety. We believe that the market has not priced a Biden win yet – this is why volatility will be high. But this situation will not last for long. Investors looking for longer-term investments should explore opportunities in the green bond space.

Contested election
Because this year will see a rise in postal ballots due to the coronavirus pandemic, there is a high probability of a contested election. In this scenario, safe-haven assets will be in the spotlight and will surge in value for as long as there is no clear winner. In this context, ten-year Treasuries and long-term, high-quality investment-grade bonds are the ones to benefit the most. Once there is a clear winner, we can expect the bond market to behave as we have indicated in one of the scenarios above.
EU corporate bonds – beware the second wave of coronavirus  

There are compelling opportunities both in the investment-grade space as well as the high-yield space within European corporate bonds. As a matter of fact, corporate spreads have tightened since the coronavirus pandemic, but continue to be wider than pre-crisis. It is important, however, to locate bonds that will prove to be resilient amid the second wave of Covid-19. We find the lower investment-grade space and better rated high-yield corporates to be the most interesting. A combination of central bank stimulus and economic recovery will favour bonds of those sectors that have been harshly hit by the pandemic.
In a complex fixed income market, cherry-picking and caution will reward investors

Although we see numerous challenges in the fixed income world, we believe that investors can still be successful in trading bonds.  We recommend investors to select risk carefully as there are clear signs of weakness in the market. In this environment, it is crucial to choose duration carefully as credit spreads might tighten further in the short term, but surprise negatively in the long run.

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article


The Saxo 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 is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, 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 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 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 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 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 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.

Trading in financial instruments carries risk, and may not be suitable for you. Past performance is not indicative of future performance. Please read our disclaimers:
Notification on Non-Independent Investment Research (
Full disclaimer (

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region


Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.