Regular readers will know that we have a positive medium term view of spread products. This is based on a number of factors; valuations in our view are reasonably attractive compared to history, we are convinced that both monetary and fiscal stimulus will remain in place for an extended period of time, and perhaps most importantly we remain at a very early stage of the new cycle. Conversely, and for similar reasons, our view on government bonds at the moment is not bullish.
All of these are strategic, medium term investment theses, but in the short run and for limited periods of time, it can be worth considering tactical positions that appear at odds with one’s medium term strategic view. At this juncture, we think we are likely to see a bit more volatility in the coming weeks, which means extending duration in US Treasuries could be a trade worth considering. The US election is a major driver of markets, and it does look like the probability of not knowing the definitive result in a timely fashion is increasing. More than 90 million people have voted already through the post, which is an unprecedented number. This might lead to delays. President Trump has also repeatedly said postal voting might lead to fraud, which increases the chances of him contesting some or all of the results. Just to give another example of events that might delay a definitive outcome, yesterday the Texas Supreme Court rejected a petition that would have put at risk the counting of over 100,000 votes in one of the state’s counties. These sorts of headlines suggest the result of the election may not be known quickly, and Treasuries might rally due to an increase in uncertainty.
In addition, a second wave of COVID-19 has hit Europe and the UK more than it has other geographies, with governments opting to reintroduce partial or total lockdowns. Though these are not as punitive to economic activity as the restrictions imposed in March and April, it is fair to say that they are worse than the base case a few weeks ago. Finally we also note that 10-year and 30-year UST yields are around 30bp and 45bp off the lows of August, respectively, which means there is some room for them to rally if uncertainty increases.
In summary, while for the medium term we remain firmly of the view that spreads remain the most attractive place in fixed income given the current cycle is only a few months old, from a tactical point of view we think there is a case for increasing duration temporarily, to help manage volatility levels that might be slightly higher in the coming days or weeks.