Fixed Income

The swift and aggressive actions by global central banks have helped stabilise market liquidity and confidence, preventing the COVID-19 shock from morphing into a financial crisis. The Fed has aggressively slashed the benchmark rates to near zero and relaunched its bond-buying programme, while interest rates remained negative in Europe and Japan.

We expect current monetary and fiscal policies to stay accommodative given that the pace of recovery will be uneven across sectors. Notably, under the Fed’s revised average inflation targeting framework, the central bank will allow inflation to run above its 2% target to make up for periods when inflation is below 2%. This reaffirms that policy rates in the U.S. could be anchored near zero for the next few years.

Having said that, we expect to see some upward pressure on longer-term U.S. Treasury yields as the economy gradually recovers. The projected increase in fiscal spending (and consequently higher budget deficit) as well as the heavy Treasury supply anticipated could also lead to higher long-term yields. Nevertheless, any increase in yields would be tempered by the Fed’s accommodative stance and bond-buying programmes.

Hence, we only expect the 10-year U.S. Treasury yields to move modestly higher to the range of 1.0% – 1.5% by end-2021. This will likely result in a steepening of the U.S. Treasury yield curve, albeit on a gradual basis.

Overall, we are underweight sovereign bonds from the U.S. and negative-yielding regions like core Europe as the asset class will likely underperform credits in an improving macro environment. In the U.S., from a positioning perspective, we are underweight longer-dated Treasuries and prefer short-to-intermediate-term U.S. government bonds as a means of portfolio diversification.

In contrast, we are more sanguine on China government bonds and expect them to outperform other sovereign bond peers in 2021, underpinned by their relatively attractive yields and broader inclusion into the global bond indices. In a low interest rate environment, China government bonds stand out as they offer one of the highest yields amongst government bonds globally. Notably, the yield on the 10-year China government bond stood at 3.3% as at end-November versus the yield on the benchmark 10-year Treasury note at just 0.9% and the 10-year German bund yield of -0.6%.