US

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.

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.

In a developed country such as the US, a scenario of rising inflation expectations is usually accompanied by a bear steepening across maturities of the underlying yield curve.

Our year-end forecast of 1.50% for the 10-year is already looking very out of date, and it would be a brave person right now to suggest that 2% won’t be touched any time this year as the recovery gets into full flow with the Fed holding its tongue.

In summary things are going quite well, and in this scenario a rise in government bond yields does not necessarily bring about a tightening of financial conditions.