UE-EN Institutional

April 2021 Fixed Income Market Update

We continue to observe demand for income-generating assets with additional relative value opportunities across the sector, quality and security levels.
April 2021

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News & nuggets

Virus & vaccine

At the end of March, the United States has administered 44 doses of vaccine per 100 people, almost six times the global rate. In the U.S., 29% of the population has received at least one dose, with 16% of the population fully vaccinated. The U.S. has been averaging 2.5 million vaccines administered per day over the last 7 days, up from 1.7 million per day at the end of February.

Fiscal policy

On March 11, President Biden signed the $1.9 trillion stimulus package passed by Congress. With an annual GDP of approximately $20 trillion, the package represents about 10% of GDP, a significant figure, particularly on top of prior packages. The package includes direct payments of up to $1,400 to individuals, extends supplemental unemployment insurance, dedicates additional funds for COVID vaccinations and includes $350 billion of aid to state and local governments.

To start with, the United States has an aging population, and this demographic shift means a large cohort of retirees will soon need cash flows to replace their earned income. As seen below, the proportion of the population above the age of 65 has increased steadily from the early 2000s, culminating in a record high at 16%—and growing. This trend is projected to continue, so regardless of what happens with growth assets in the short-term, demand for income will likely rise as more Americans move into their golden years.

Treasury market

Short-term rates converged to zero this quarter with repo and T-bills even trading at negative yields. This dynamic was driven by a confluence of factors including planned decline in cash balance in the Treasury General Account (TGA), significant lending from GSEs, and a pickup in money market fund inflows. With the TGA expected to decline by $700 billion through July, downward pressure on front end rates is likely to persist, however the Fed did increase its reverse repo facility at the March meeting in an effort to put a floor under short rates.

The U.S. Treasury index was down 4.25% on the quarter – the worst quarterly return since the early 1980s when Paul Volker broke inflation’s back by raising the Federal Funds Target Rate to 20%.

Monetary policy

At the March 16-17 meeting of the Federal Open Market Committee, members updated their economic projections, with highlights including increasing GDP projections for 2021 from 4.2% in December to 6.5%. Projections are for growth of 3.3% in 2022 and 2.2% in 2023 with a long-run growth expectation of 2.3%. The median projections for unemployment at year end were revised lower from 5.0% to 4.5% (unemployment was 6.2% at the time of the meeting.)

With broad consensus for economic improvement, some market participants have become concerned about the prospects for inflation and consequently for its impact to Fed policy. The Fed’s expectations for inflation remains moderate with projections of 2.2% core inflation in 2021, 2.1% in 2022 and a 2.0% long-run rate.

The more positive economic projections did not alter the Fed’s stance on the current need for accommodation. As expected, the Fed did not raise the Fed Funds rate, nor did it alter the current pace of asset purchases.

Earnings

Corporate earnings expectations continue to increase. Expectations for the first quarter are for profits growth of 23.3% versus expectations for 15.8% growth as of December 31. This comes on the back of positive fourth quarter growth after prior expectations of a nearly 10% decline in earnings. Even with the 4.0% earnings growth in the fourth quarter, full year 2020 earnings declined -11.2% with revenue declines of -0.8%. For the full year 2021, corporate earnings are expected to rebound sharply, with earnings growth of 25.4% and revenue growth of 9.6%.

Outlook and conclusions

The near doubling of interest rates in the quarter has deservedly garnered significant interest, though given the magnitude of the rebound in other asset classes, this move is more of a catch-up as rates were effectively the laggard. This is not to suggest we believe rates will rise to the degree seen from other asset classes, indeed our view is that many of the factors pushing rates higher have been pulled forward rather than playing out over the course of the year. Layers of fiscal stimulus upon an already recovering economy suggest strong growth for the corporate sector and overall economy; this year could be the strongest for growth in a decade. Further, with vaccinations becoming more widely available, pent-up demand is likely to be unleashed. At the same time, growth alone will not determine the path of fixed income. Our view on inflation is relatively moderate, which would put less upward pressure on rates. Further, a variety of factors are likely to support bonds in the near-term. With equities closing at record highs, but bonds experiencing a negative quarter, we expect to see some degree of asset class rebalancing supporting rates. Additionally, U.S. rates are meaningfully higher than global equivalents, but hedge costs are low enough versus that premium that U.S. assets are likely to attract additional inflows. Treasuries are not the only fixed income assets likely to benefit in this environment. We view spreads on credit and many securitized assets as tight in a historical context, but likely to perform well with support for the asset class and a robust economic landscape. Within the broader sectors, we see attractive pockets looking within market segments. For example, while observing the spread tightening that has occurred for high yield in the past year, we see value in the higher quality segments of high yield versus both lower  quality investment grade and lower quality high yield. Though the move in rates has attracted attention, in our view the increase in rates has yet to quench investors’ thirst for income. We continue to observe demand for income-generating assets with additional relative value opportunities across the sector, quality and security levels.

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Disclosures

All investments involve risk, including the possible loss of principal.

This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security.  The opinions expressed here reflect our judgment at this date and are subject to change.  Information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.  This publication is prepared for general information only.  This material does not constitute investment advice and is not intended as an endorsement of any specific investment.  It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report.  Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.  Investment involves risk.  Market conditions and trends will fluctuate.  The value of an investment as well as income associated with investments may rise or fall.  Accordingly, investors may receive back less than originally invested.  Investments cannot be made in an index.  Past performance is not necessarily a guide to future performance.

Taplin, Canida & Habacht, LLC is a registered investment adviser and a wholly owned subsidiary of BMO Asset Management Corp., which is a subsidiary of BMO Financial Corp.

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