Bond Bears In A Pandemic

The new week will be dominated by talk of a “skinny” fiscal stimulus deal in the US.

Specifically, the key questions are 1) whether Mitch McConnell can be convinced to support the $908 billion bipartisan compromise package backed by Joe Biden, Nancy Pelosi, Chuck Schumer, and a hodgepodge of moderate Republicans, and 2) whether virus aid will be Elmer’s-glued to the omnibus bill that Congress needs to finish so the government stays funded.

There’s little utility in recapping the story or otherwise lampooning the absurdity of it all again. I imagine the next several days will present ample opportunities in that regard. Those in need of a refresher can read more in the linked post (below).

Read more: Scotch Tape & Paperclips

Suffice to say this is not how government is supposed to function. Everything needn’t be an exercise in brinksmanship and every issue shouldn’t be viewed as just another opportunity to blackmail the other side on the way to extracting leverage.

November’s below-consensus jobs report helped galvanize lawmakers and significantly increased the subjective odds of the compromise bill gaining more traction. That, in turn, pushed up long-end yields, as the prospect of a lame duck deal (seen as a long shot just a week ago) gets priced in.

Outside of stimulus talks, there’s not much in the way of data on the docket to move the needle. CPI is on deck and while inflationary pressures are building according to the color accompanying November PMIs, it’s hard to imagine getting a print that’s unequivocally “hot” under the current circumstances.

Make no mistake, the nascent bond selloff is a big storyline for market participants. Some worry rising yields will derail the equity rally, while others point to rising breakevens as an almost unequivocally positive development considering the world is struggling to recover from a deflationary supernova (i.e., the pandemic).

Notably, TIPs got their second largest weekly inflow on record over the latest EPRF tabulation period.

In addition to the stimulus talks, bond bears are eying the supply calendar. Treasury will sell $118 billion in notes and bonds this week.

“Higher odds of a fiscal stimulus package by year-end, albeit a skinny deal, are propelling risky assets and Treasury yields higher,” SocGen’s Subadra Rajappa said, in a note out late last week. “What really stands out in the price action is the sharp rise in inflation expectations as the reflation trade seeps into the bond market.”

Of course, over the medium- to longer-term, what matters for yields is the trajectory of the public health crisis. The pandemic collapsed the global economy via the largest demand shock in modern history, threatening to push the world into a deflationary spiral. The universe of negative-yielding debt is now at record “highs” (and “highs” is a kind of strange, paradoxical misnomer in this case).

A vaccine is a panacea (or so we’re told) and evidence of a return to “normal” would presumably be the most straightforward way to achieve sustainably higher yields.

“While it is hard to read too much into the recent price action… the longer-term trend should be towards a gradual move higher in yields,” Rajappa went on to say, noting that even in SocGen’s bull case for Treasurys that includes a scenario in which “the vaccines fail to deliver,” the bank sees the 10-year staying near 1%. “We do not see a path towards re-testing the low of 50bp, as weakness in fundamentals will likely mean greater fiscal stimulus,” Rajappa remarked.

But there are questions about the logistics of vaccine distribution and concerns about the public’s willingness to be vaccinated. Even if you assume those supply and demand hurdles can be cleared, the effects of the pandemic will linger and the “shape” of the recovery will matter when it comes to determining how much additional stimulus is needed, what form it should take, and where it should be targeted.

Read more: 50% Of Population In Major Developed Markets Will Be Vaccinated By May, Goldman Projects

“In the year ahead, the performance of the US rates market will mirror 2020 in one primary way — as goes COVID, so goes the real economy,” BMO’s Ian Lyngen and Ben Jeffery wrote, in their year-ahead rates outlook.

“Dueling forces represent the largest drivers for market expectations, with an array of derivative concerns contributing to the anticipation for either a more rapid rebound in growth or a deeper and prolonged contraction,” they noted, adding that “this backdrop, unfortunately, doesn’t conform to a trending US rates market and leaves investors facing the realities of a trading range that will remain in place for the foreseeable future.”

I should note: If Democrats somehow managed to sweep the Georgia runoffs, the whole game would change overnight, as expectations for fiscal stimulus in 2021 would need to be ratcheted materially higher.