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Fixed Income Perspectives April 2021

Quarterly macro and market insights from Capital Group’s fixed income team


 


Optimism on the US economic outlook increased as the COVID-19 vaccination rollout accelerated, and the new Biden administration embarked on expansive fiscal policy.


The US$1.9 trillion American Rescue Plan Act was signed into law in March. This plan provides for US$1,400 direct payments to many Americans; it also extended unemployment aid to the millions who remain out of work and made low-interest-rate loans available to small businesses. The nearly US$400 billion of direct payments included in the stimulus amounts to the largest direct infusion of money since the pandemic began.


Money supply has increased significantly and looks set to climb even further in 2021. With this latest round, overall stimulus appears to more than offset income lost due to business closures and job losses.


Money supply is more than 25% above pre-pandemic levels

Source: Federal Reserve Bank of St. Louis. Data through February 2021 (latest available). The M2 measure includes cash, checking, savings and small-denomination time deposits, as well as other easily convertible near money. 

Effective vaccine distribution should see the US on track to exceed its pre-COVID trend GDP by 2022. That said, the economy has over 8 million fewer jobs than in February 2020, the month before pandemic-related job losses began.


The official unemployment rate and U-6 rate (which includes discouraged and part-time workers seeking full-time positions) stood at 6.0% and 10.7%, respectively, in March.


Service sectors and certain other areas will take longer to heal, or could be in the early stages of structural change. Attendant scarring in the labour market may impart downward pressure on inflation in the medium term. That said, we expect service-based areas to benefit from pent-up demand as the economy reopens.


The market has pulled forward interest rate hike expectations, despite some near-term deflationary factors. The forward market, for instance, has priced in roughly 80 basis points (bps) of rate increase by the end of 2023. We believe this is a more aggressive rate path than the US Federal Reserve (Fed) will ultimately deliver.


US Federal Reserve Chair Powell reaffirmed policymakers’ plan to be patient. The dot plot, which summarizes the outlook for the policy rate, indicated rates were likely to remain on hold through 2023, which aligns with our outlook.


Effective COVID vaccination may boost US growth by over 3%

Sources: Capital Group, Bloomberg, US Bureau of Labor Statistics, Haver Analytics, HistStat. *Recovery scenarios as of March 2021, based on estimates from Capital Strategy Research. Vaccine scenario assumes herd immunity by Q3 2021 (~90% vaccine efficacy, across ~66% of population).

Chair Powell said the Fed will look through a transitory rise in inflation above 2% this year due to base-effects and a demand surge as the economy reopens. With respect to rising bond yields, Powell said he would be concerned by a disorderly or persistent tightening in financial conditions that threatens the Fed’s goals. However, financial conditions remain extremely accommodative despite the sharp rise in yields. His comments, therefore, suggest the Fed will not get in the way of the market unless conditions shift.


In other developed markets, growth is also rebounding toward pre-pandemic levels faster than employment. Parts of the eurozone remain under lockdown, with restrictions tightened in certain countries amid a bumpy rollout of vaccinations. Eurozone manufacturing data show surprising economic resilience in the first quarter. With the vaccine rollout poised to accelerate in coming months, we expect an easing of restrictions to support a stronger recovery — especially in services. Likewise, manufacturing should benefit from a robust recovery in the global industrial cycle.


Eurozone manufacturing data show surprising economic resilience in the first quarter. With the vaccine rollout poised to accelerate in coming months, we expect an easing of restrictions to support a stronger recovery — especially in services. Likewise, manufacturing should benefit from a robust recovery in the global industrial cycle.


Easing of restrictions in the UK should see its economy rebound and outpace the eurozone.


The market sees the Fed hiking by 1% before year-end 2023

Source: Bloomberg. Market expectations for interest rate hikes by year-end 2023, imputed from market pricing though 31/3/21.

In China, economic growth may actually be plateauing. Having begun its recovery sooner than other countries, the credit impulse and tailwind from fiscal stimulus are fading. Monitoring of economic and the Purchasing Managers’ Index data in coming months — as well as copper and steel demand — should provide some further clues on the outlook.


Valuations across asset classes suggest markets are looking through near-term downside risks. Even so, the pandemic will likely influence market sentiment in coming months. Vaccine efficacy, the spread of COVID-19 variants and the potential for increased incidence as economies reopen are all potential sources of volatility.


Given our positive near- to medium term outlook, we think setbacks could offer good entry points for longer term investors. Clearly, rate risk has moved front and centre for many investors. However, the rise in yields witnessed since late February, appears overdone, in our view.


Employment hasn’t fully bounced back from the pandemic

Sources: Capital Group, Bloomberg, Japanese Ministry of Health, Labour & Welfare, US Bureau of Labor Statistics and statistical agencies of the UK and Germany. Latest data available as of March 2021.

 

Risk factors you should consider before investing:
  • This material is not intended to provide investment advice or be considered a personal recommendation.
  • The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
  • Past results are not a guide to future results.
  • If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
  • Depending on the strategy, risks may be associated with investing in fixed income, derivatives, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.


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Past results are not a guarantee of future results. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.