What’s in store for 2021?

What’s in store for 2021?

2021 Outlook Summaries

Rates markets

2021 like 2020 will be another record-breaking year. It now seems reasonable to assume that Covid-19 vaccination programs will be rolled out in the first half of 2021, leading to a very different economic landscape by the end of the year. Economic growth should be strong as business and consumer confidence increases, investment rises, and pent-up demand is funded by the drawdown of savings. How quickly this happens and whether the supply side of the economy is still in sufficiently good shape to fulfil this extra demand will determine how the government debt markets behave. It is highly likely that 2021 cannot make up for the damage of 2020 completely and thus we expect all the major central banks to maintain their accommodative stance over the year. But what is likely is that the output gap, the measure of spare capacity in the economy both locally and globally, will be smaller at the end of 2021 than at end 2020; thus the prospects for a change in central bank stance must be increasing by then. We would expect yields on long dated government bonds to reflect that and therefore to rise modestly in 2021.

 

Investment Grade markets

In the short term we expect the ongoing stimulus from various central bank policies, in particular the ECB’s CSPP programme, coupled with expectations of a significant global economy recovery in 2021 to continue to support investment grade credit markets. In particular, we would expect those sectors most negatively impacted by the pandemic (transport, leisure, hotels, etc) to see a marked improvement in trading environment, with subsequent further improvements in the price of their bonds. Having said all that, at current aggregate market valuations there appears to be little margin for error. Credit spreads for many sectors, especially the more defensive ones, are very low compared to recent years, and there are a number of obstacles still to overcome. The current lockdowns impacting many European economies could last well in to 2021, and there is still a lot of uncertainty about how long it will take to roll-out vaccine programmes and, therefore, when these lockdowns could be lifted. Significant delays to the rolling out of an effective vaccine will limit the pace of the economic recovery next year and could be a catalyst for credit markets to weaken. Moreover, credit investors are likely to start projecting a gradual unwind of the very accommodative policy that has been put in place by the major central banks that have been so crucial in bolstering investment markets. We do not expect the major central banks, and the ECB in particular, to start tightening policy any time soon, but at some point, perhaps in the 2nd half of 2021, they will need to slowly take their foot of the gas. The timing and signalling of this to investors will be crucial to maintaining a relatively orderly market.

 

High yield markets

The positive momentum in high yield looks set to continue into 2021, with the recent encouraging news on vaccine development serving to underpin risk sentiment for the asset class and assuage investor concerns over the tail risk of a protracted lockdown scenario. The outright valuation picture is fairly constrained, with spreads comfortably inside long-term average levels in both European and US high yield, however the asset class continues to offer compelling value versus other fixed income asset classes and is one of the rare areas where significant positive yield is still available. The market has experienced a very firm technical in 2020 and this should continue to exert a positive impact moving into 2021 as demand for high yield remains strong. Central banks are maintaining their stance on easy monetary policy, fiscal stimulus is likely to provide further economic support, and progress on the vaccine should allow a resumption of activity sooner than many had anticipated. Whilst default rates may yet rise further, we anticipate these are likely to remain well-contained as most companies are able to freely access capital. Given this backdrop, spreads look likely to grind tighter and we should see further compression between lower rated debt and higher quality BBs.

 

Summary

The policy of central banks will be key to returns in 2021. It is reasonable to expect that policy rates, quantitative easing and other monetary policy tools will be actively used throughout 2021 but there could be fearful anticipation of their removal. Should vaccines prove swift and effective the lockdowns and disruption caused by Covid-19 will fade. The Bank of England will want to see Covid-19 dealt with before any removal of current policy tools. Thus, we expect Gilt yields to move moderately higher – measured in basis rather than percentage points. Covid-19 scars will remain, economic growth will play catch up, but the Treasury predict 2019’s GDP not being reached until after 2025. Credit markets enter 2021 benefitting from strong buying and “full valuations”. As the world normalises there is still room for the most affected sectors (e.g. hospitality, leisure) to perform but better-quality credit is priced as expensively as any time over the past quarter of a century. The global high yield market still has potential with a good vaccine outcome; single B credits can still outperform BBs. The starting point of higher coupons will give investors comfort and protection should there be a whiff of “normalisation” of central bank policy. Brexit, whilst overshadowed by Covid-19, remains a wild card. A rewind of the measures put in place in 2020 will be slow but the painful experiences of removing accommodative policy in Europe in 2011 and the US in 2013 still casts long shadows over central bank thinking.

Adrian Hull

Head of UK Fixed Income

Adrian Hull is Head of UK Fixed Income

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