Weekly Bond Bulletin

26 November 2020

Keeping chips on the table

Despite a murky fundamental picture in the short to medium term, bond markets are looking ahead to a post-Covid world, with investors appearing to put more chips on the table and position with a risk-on stance.

Fundamentals

Opposing fundamental forces mean there seem to be more questions than answers in determining the path ahead at this point. The bears argue that Covid-19 cases continue to grow, especially in the US, and earnings have a long way to recover. The bulls, on the other hand, are taking comfort in the latest vaccine news. AstraZeneca/Oxford’s vaccine may have a lower efficacy rate of 70%, but it benefits from far-reaching supply agreements, lower logistical constraints and a cheaper price, making it especially useful for lower income countries and thereby supports the case for a widespread rollout of vaccines in 2021. Geopolitics are also arguably less of a tail risk as the US General Services Administration has officially acknowledged Joe Biden as the winner of the US election. The data is still mixed, however. Within the G4, for instance, manufacturing sector purchasing managers’ indices in general have held up better than services (except in the US, where both improved). The low yield environment does bode well for default rates and we are already witnessing a rotation into more cyclical names and sectors, which in turn is enabling some of the least financially stable corporates to fund cash burn in capital markets. The question is how long they will be willing to do so and if support from central banks and governments will continue in the meantime.

Quantitative valuations

November has already been a strong month for risk markets thanks to the positive vaccine news. In developed markets, global high yield and investment grade have returned 3.9% and 1.7% for the month to date, as of 24 November. Emerging market corporates have posted returns of 2.4%, while sovereign hard and local currency debt have returned 3.8% and 1.1% respectively. There is no doubt that investors are considering whether or not it is a good time to lock in profits; however, we believe that it is better to stay the course, as long as you have a long time horizon.

Technicals

Corporate bond supply has been elevated this year, yet strong demand factors have allowed for continued spread compression. November’s fund flow picture is distinct in that riskier asset classes have been the benefactors, while safer asset classes/products, such as money market funds and government bonds, have witnessed significant outflows. Within the funds themselves, beta exposures suggest that positioning has moved to a risk-on bias, not just by rotating into cyclical names but also by dipping down in credit quality. For example, US CCC rated securities have outperformed BBs by 3.5% in the month to date.

Fund flows in November have been geared towards riskier asset classes

Source: J.P. Morgan Asset Management; data is for the month to date, as of 23 November 2020. Gov = government, IG = investment grade, HY = high yield, local = local currency, hard = hard currency, corp = corporate. AUM is assets under management. LHS = left hand side. RHS = right hand side.

What does this mean for fixed income investors?

Following a strong bout of returns it is no surprise that investors are considering taking some profits heading into the end of the year, particularly as the near-term picture for the global economy has worsened with the resurgence of Covid-19. However, the promising vaccine news does make the eventual path to recovery clearer. We acknowledge that momentum is in favour of risk-on positioning and higher betas, while we are approaching seasonally favourable months from a returns perspective. We believe continued central bank support means that it is not yet time to realise profits as spreads could well grind tighter from here.

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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26 November 2020
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