US

As the Delta variant establishes a hold in many countries, forcing some governments to re-assess reopening policies, the market is beginning to feel its impact. The implication on growth remains unclear, but early indications suggest the growth rate may have peaked for this year, albeit continuing its recovery.

When combined with other prevalent market dynamics, the favourable ratings trend paves the way for a highly supportive fundamental terrain as we advance through the cycle and one that is ideal for portfolio managers selecting credits.

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.

Yesterday the US Federal Reserve released the results of its annual bank stress test, subjecting the 23 largest US lenders to a punitive set of scenarios. Some observers might think the events since March 2020 had been sufficient to test the resilience of the banks, but the Fed went beyond this recent real-life challenge and tested bank balance sheets against a range of hypothetical crises.

With all of the recent data pointing to higher inflation expectations and the Fed expected to maintain a transitory interpretation, we will be focusing our attention on comments from the various regional Fed presidents on conditions that could prompt a tapering move at some point in the future.

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.

From our perspective, the potential wage pressures we see make us uncomfortable with 10-year Treasury yields at current levels, despite their significant rise since the start of the year.

Having witnessed the most remarkable turnaround in risk markets over the last 14 months, it makes sense to take stock as fundamentals look to us to be approaching optimal levels. Credit spreads have ground into levels not far from the prior cycle’s tights, and while we remain confident in the underlying fundamentals and a good technical backdrop, recent developments mean that despite this constructive view, our risk appetite has ticked down slightly.
 

At 8.1m, the number of job openings as of March 31 was the highest it has been since the data series began some 20 years ago.

Markets can often be tricky for investors in May as bond issuers take advantage of a window of opportunity following the Q1 earnings season and ahead of the typical summer lull. This often results in heavy supply in late April and early May, hence the old trader adage of “sell in May and go away”.

Crucially while the Fed may wait to see the evidence, markets won’t, and we therefore expect a ‘second wave’ of Treasury selling to happen well before then.

This recent stability in the rates curve suggests to us that for now the market is listening to the Fed’s rhetoric and as a result the UST market feels better balanced.