Weekly Bond Bulletin

15 October 2020

Catching a blue wave

With markets increasingly expecting Joe Biden to win the US presidential election and the Democrats to take control of the Senate, should investors be moving to lower their duration positioning?

Fundamentals

There are two narratives currently driving risk-on sentiment in bond markets: fiscal stimulus and a Covid vaccine. The US presidential election outcome will likely have an impact on the scale and timing of US fiscal stimulus measures and could also raise volatility. Polls are pointing towards a victory for Joe Biden and for Senate Democrats (a blue wave). While the accuracy of polling, particularly in light of the 2016 election outcome, is never certain, Biden has gathered a stronger lead than Clinton had at this stage in the campaign. As this year has progressed the narrative surrounding a Biden presidency has flipped, with previous concerns around increased regulation and higher corporate taxes replaced by hopes that a large fiscal stimulus programme would be put in place relatively quickly after the election (whereas issues such as tax reform would take longer to implement). Besides the US election, vaccine developments are also being watched closely by investors. An effective Covid vaccine should eventually allow in-person services to complete the recovery already largely achieved by retail sales and manufacturing. While we can’t predict the timing, we do know that advanced vaccine trials are still targeting an efficacy signal by late October or early November.

US election polling is swinging in favour of Biden

Source: Real Clear Politics; data as of 13 October 2020.

Quantitative valuations

Since reaching a floor of 0.51% in August, the benchmark US 10-year Treasury yield has gradually increased to a current level of 0.73% as investors have priced in the prospect of a blue wave in the US election. We had expected Treasuries to remain at the lower end of a 0.5%-1.0% range until a change in the macro outlook, such as a vaccine or a Democratic sweep, pushed them higher. Since the chances of these two catalysts have recently increased, we now expect Treasuries to move towards the higher end of that range before year end. In terms of relative valuations, we think German Bund yields may also move higher, but to a lesser extent than US Treasuries, especially as the European Central Bank is likely to extend quantitative easing in December. (All data as of 13 October 2020).

Technicals

Investors have already been shifting gears in their portfolios as markets have started to price in a Biden victory and a vaccine, with duration positioning surveys suggesting a move broadly to a more neutral, or short position. If a Biden victory or blue wave does occur, supply of US Treasuries would be expected to increase in order to fund the touted fiscal spending measures. Overall, a larger pool of debt with less buying appetite from investors should allow bond yields in the US to drift higher.

What does this mean for fixed income investors?

We think the recent reduction in investors’ duration positioning is justified, given increasing market expectations of a Biden victory and the development of an effective Covid vaccine. However, we are wary of a potential lag effect. For example, in the event of a blue wave in the US election, there would be a lag between the election result and the implementation of fiscal stimulus measures. And with the development of a vaccine, even if an effective vaccine is approved it will take time for it to be widely distributed. Nonetheless, we would expect markets to react significantly to either eventuality and therefore believe that it may be the right time to reduce duration in portfolios, albeit not holding an outright short position quite yet.

About the Bond Bulletin

Each week J.P. Morgan Asset Management’s Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.

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15 October 2020
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