‘Structural Issues’

If you were a bond bear headed into the US election, things didn’t go entirely according to plan.

Whenever you endeavor to talk about positioning in rates, caution is warranted, as there’s ample scope for misinterpretation and the drawing of spurious conclusions at virtually every turn.

With that obligatory caveat, it’s worth noting that TLT, BlackRock’s popular long bond ETF, suffered a $1.17 billion outflow last week, the largest since March’s Treasury market meltdown and the second largest of the year.

As indicated in the chart’s subheader, some of the outflows could easily be attributed to profit-taking. After all, the vehicle had its best day since April last Wednesday, when the prospect of divided government prompted a powerful bout of bull flattening as yields plunged on expectations for less government spending, slower growth, and a Fed that’s forced to remain “in the game,” as it were, quite possibly via WAM extension and ramped up asset purchases in the absence of a sufficient and sustainable fiscal impulse.

But whatever the rationale for last week’s exodus from one of the world’s most recognizable bond ETFs, it looked like a good move come Monday. Pfizer’s encouraging (to put it mildly) coronavirus vaccine data pushed long-end yields sharply higher, in what was poised to be the biggest selloff since March.

This is challenging for any thesis that assumed range-bound rates. There’s also scope for Georgia’s upcoming Senate runoffs to add to any upward pressure on yields in the event the odds move in favor of those seats flipping to Democrats. That’s unlikely, but were it to materialize, it would have dramatic market implications, as tax hikes and bigger spending would go from “outside chance” to “base case” literally overnight in January.

I doubt Monday will do much to shake the disinflationary conviction of those who think the likelihood of divided government, new lockdowns in Europe, the “scarring” effect from the pandemic across developed economies, and preexisting structural factors will ultimately serve to keep yields anchored and curves flat.

“While the medium-term outlook continues to point to some steepening of the curve as the Treasury’s duration supply exceeds the pace of the Fed’s asset purchases, the near-term outlook looks relatively rangebound amid the reduced prospects for a significant fiscal package and valuations looking broadly fair,” JPMorgan wrote late last week. “Our strategists stay neutral on duration and the curve after having closed curve steepeners.”

To be sure, everyone knew positive vaccine data was in the offing, but the assumption was (and probably still is) that any economic boost from a shot is still months (at least) away. In the near-term, Europe is grappling with new lockdowns that are almost guaranteed to produce a double-dip downturn, while the US is on the brink of witnessing hospitalizations hit levels last seen during previous virus peaks.

Meanwhile, the effects of the pandemic and the oil price collapse are still weighing on inflation both in the US and across the pond. Europe is still posting negative headline prints, for example.

We’ll get an updated read on US CPI later this week.

Commenting in a Friday note, Deutsche Bank’s Stuart Sparks wrote that even a “blue wave” electoral result would only reprice the market sustainably in the event fiscal stimulus was “large, consistent, and designed to mitigate offsetting increases to private sector savings.”

A “weak-form blue sweep,” (as he described a potential win for Democrats in the Georgia runoffs) isn’t likely to bring about a wholesale rethink of fiscal policy inside the Beltway.

“At present, additional stimulus beyond pre-election Republican negotiating levels of $500 billion appear increasingly remote,” Sparks went on to write. “The US electorate, during a recession caused by a global pandemic, has chosen not to elect a government structure that looks willing or able to embark on a new period of greater fiscal activism.”

There’s a parallel with the vaccine. Many Americans will be skeptical of a shot, albeit for different reasons depending on party preference. It’s possible that, to adopt (and adapt) Sparks’s language, the US electorate, during a recession caused by a global pandemic, will choose not to get the vaccine.

He went on to write that “a weak fiscal impulse appears to be a structural issue in the US.” Just like mass undereducation.