Monetary Policy

Given the magnitude of the amounts involved we do think there is potential for some temporary volatility in the US Treasury market as the volumes change. We will be keeping a keen eye on both in the months ahead.

While we don’t expect any material spread widening in the near term, we remain extremely wary of higher duration bonds given our view that the potential persistent inflation suggested by recent data isn’t priced into US Treasury yields, which currently sit around 1.58% at the 10-year point.

After unleashing the strongest combined emergency package we have ever seen in 2020, central banks are now entering perhaps the most challenging phase of their COVID-19 response, trying to balance the economic recovery while at the same time having to reassure the markets they can control the threat of runaway inflation.

Had this happened a month ago, we suspect the move would be materially more pronounced, and the muted reaction indicates to us that markets are now quite comfortable with the current levels of expected growth, forecast inflation, and yields.

The Fed maintained its dovish stance on Wednesday and offered very little in the way of resistance to the ongoing rise in US Treasury yields.

The bear steepening of the US Treasury curve has undoubtedly been the story of 2021 so far for fixed income investors, many of whom will have felt the adverse impact of the broad rates sell-off on their portfolios.

Yesterday the ECB released their guidance to banks regarding shareholder distributions. They have reiterated that banks should exercise extreme moderation on variable remuneration (bonus payments) and have set limits for dividend payments to equity holders and prudence on any share buy-back schemes.

Speed of market movement will be a feature of this recovery as the market realises many of the same trends are firmly in place, and with the incredible technical backdrop this means lower yields as the cycle progresses.

Thursday’s ECB meeting left us in little doubt that we should expect some serious action in December, including the possibility of some new, as yet unused measures.

Unlike the past six months, where nearly all new deals performed well in the secondary market, from here on in that is far from guaranteed. Expect winners and losers.

Overall, in our view there may be some temporary volatility ahead which investors can try to sidestep or even take advantage of, but it’s probably not worth trying to be too cute as our medium term outlook is still constructive.

There have been two topics concerning the yield curve in the press over the last few days, which we think merit closer attention. As regular readers will know, the US yield curve in particular is closely followed by market participants and can dictate a lot of what happens in fixed income markets globally.