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December 2020 Fixed Income Market Update

News & nuggets

Election

The 2020 U.S. elections were significantly tighter than polling had suggested and more in line with our projections for a close race. After an initial delay, Democrat Joe Biden has been broadly named as the winner, though President Trump continues to challenge results. Notably, projections for a ‘blue wave’ did not materialize with Republicans gaining seats in the U.S. House (+11 as of month end) and losing only one Senate seat, leaving the Senate with 50 Republicans and 48 Democrats pending the results of two run-off contests in Georgia. Democrats need to win both to control the Senate (a 50-50 tie would result in the vice president casting the tie-breaking vote, hence Democrat control.) Republicans are slightly favored in those races, but even if Democrats prevail, their majority in both houses would be quite narrow.

The slim majorities and potentially not controlling the senate are likely to moderate the ambitions of the new president. Some of the less market friendly policies envisioned, such as tax hikes, are much less likely to be achieved near-term. Similarly, the cabinet picks named by Biden to date appear to have been designed to gain approval in a tight senate.

One area of market concern is that, absent a significant single party majority, the likelihood of a significant stimulus package has declined. Both parties have appeared willing to support their own version of a stimulus package, but there are questions as to whether a compromise package can be achieved, what it will contain and on what timeline.

Vaccine

Shortly after the election, Pfizer announced the vaccine it has been developing is over 90% effective. The results and timing of availability were more positive than expected. Shortly thereafter, Moderna announced a rival vaccine with even higher efficacy and AstraZeneca followed with an announcement of its own version.

Amidst the optimism for effective vaccinations becoming available en mass and hopes that it would end the global pandemic, the current situation remains more tenuous with cases increasing and a growing number of restrictions being re-implemented.

Monetary policy

U.S. Treasury Secretary Mnuchin informed the Fed that the Treasury would not renew the 13 (3) emergency loan programs established earlier in 2020 as market supports during the initial phase of the coronavirus crisis. The expiring programs include the funding for the Fed’s corporate bond purchases, municipal lending and Main Street Lending programs.

The Fed responded to the lack of renewal with a statement that they “would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy.” The Federal Open Market Committee’s November 4-5 meeting was relatively uneventful. Rates were left unchanged as expected and the wording of the Fed statement was nearly identical to the prior meeting. In the subsequent release of the minutes, members discussed increasing policy accommodation vis a vis adjustments to the asset purchase program; this approach has come into greater focus after the aforementioned change in policy from the Treasury department.

Outlook

In our view, the speed of development and efficacy of Covid-19 vaccines has generated well warranted market enthusiasm. Nonetheless, before vaccinations can help end the coronavirus pandemic there is still a significant upsurge of virus cases and increasing economic restrictions to reckon with. Similarly, the election results pose challenges near-term with a likelihood of decreased or delayed stimulus, but longer term divided government has tended to bode well for the economy. The approaching end of the Fed’s corporate bond buying program bears monitoring, but as of today has become less relevant as the economy and markets continue to heal. Remarkably, IG credit spreads are within eyeshot of where they began the year. Though this is at some level difficult to fathom given the challenges of 2020, credit has not recovered as fully as other asset classes such as equities, which are meaningfully positive for the year. High yield, though experiencing a significant rebound, remains relatively cheaper as do pockets in the securitized space. At this juncture we see little to drive rates meaningfully higher, leaving us comfortable with duration. We observe value in credit, both IG and HY, but mindful of valuations given the uncertainties that remain.

Originally Posted in December 2020 – December 2020 Fixed Income Market Update

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