Inflation concerns remain low at the end of the third quarter with the 10-year Treasury closing at 1.49%. This is just slightly higher than the 1.47% yield posted on 6/30/21. Looking out over the next few years, growth and inflation expectations in the above chart are tame. (source: Bloomberg).
Inflation concerns subsided in the second quarter. The first half 2021 Investment Grade Index total return of -1.06% was a sharp reversal of the first quarter’s -4.5% (source: CreditSights and BAML). The High-Yield Index resiliency strengthened with a first half 2021 total return of 3.70% versus the 90 basis point positive return for the first quarter (source: ibid).
Inflation concerns rocked the bond markets during the first quarter driving the Investment Grade Index down –4.5% (source: CreditSights and BAML). However, the High-Yield Index showed resiliency and posted a 90 basis point positive return for the first quarter (source: ibid).
The Federal Reserve’s Vice Chairman, Richard Clarida stated that “the development of several effective vaccines indicates to me that the prospects for the economy in 2021 and beyond have brightened and the downside risk to the outlook has diminished (source: Bloomberg news 1/8/21). He did caution that it would take “some time” for economic activity and employment to reach the peak level of last February.
Even with all the uncertainties created by the pandemic, third quarter GDP forecasts are up around 30%. The Federal Reserve’s Bullard weighs in at 30% (source: Wall Street journal 10/6/20), while J.P. Morgan forecasts 34.5% (source: J.P. Morgan Global economic outlook survey).
It has been barely 4-months since the pandemic lead to the shutdown of not only the US but most nations’ economies. The human and economic damage and suffering will continue for some unknown time.
The recent violent fall in prices of many asset classes is on a scale most of us have not experienced. The repricing of equities has lead Malkiel (quoted above) to argue for investors to increase allocation to equities. By extension, this would apply to other asset classes experiencing significant price declines whose fortunes are tied to corporations and businesses. So, corporate bonds would also appear to be attractive investments.
2019 was a banner year for stocks and bonds , and 2020 is starting out robustly. The new Canada Mexico trade deal signed by President Trump and the trade agreement with China could lead to higher GDP in the USA, given the more level playing field they create. Also, we could see a large increase in corporate capital spending now, since the deals reduce many trade uncertainties. Furthermore, the China deal leaves many of the tariffs in place, which is meant to motivate the Chinese to enact the broader phase two trade agreement.
As we move into the 4th quarter of 2019, talk of negative interest rates continues. The recent U.S. Govern-ment’s auction of 30-year bonds on Thursday, October 10 drew a record low yield of 2.17% (source: Bloomberg 10/10/19). This is considered a strong sign of declining investor expectations for economic growth and inflation. The trend is global with the U.K. and Germany also posting record low yields for their respective 30-year bonds (source: Bloomberg 10/10/19).
Rising uncertainty and muted inflation “strengthens the case for a somewhat more accommodative stance of policy.” Officials “will act as appropriate to sustain the expansion” – Federal Reserve Chairman Jerome Powell as reported in The Wall Street Journal 7/16/19.
What a difference a year and even 6-months makes. For the past two years, Investors were fleeing the bond markets as forecasting rising Treasury Bond yields portended red ink. Just last October the 10-year Treasury Bond yielded 3.24% at its peak (source: Macrotrends 10-year Treasury historical chart 7/17/19).