1. Growth: Expect robust 2021 growth as conditions continue to normalize post-vaccine and policy remains accommodative.
- Key point: Larger fiscal stimulus expectations have begun to raise forecasts for growth.
- Bottom line for fixed income investors: Expect growth to keep upward pressure on rates, but also support spread levels.
- Key point: Inflation expectations have moved higher, as evidenced by TIPS, but the move is in-line with previous recoveries.
- Bottom line for fixed income investors: Inflation expectations will continue to drive further gains in TIPS near-term, but we don’t see an inflation scare causing rates to move beyond a tight range during the first half of 2021.
3. Policy: The Fed has made it clear that it will remain accommodative in 2021, and expectations are for quantitative easing (QE) purchases to remain on pace until late 2021.
- Key point: Tightening and tapering are different things, and we don’t expect any form of tightening in 2021 (balance sheet shrinkage, rate hikes); tapering the pace of purchases in the face of a robust recovery is a scenario for late 2021, but would be gradual and well telegraphed by the Fed.
- Bottom line for fixed income investors: Vaccines and the economic recovery have moved long rates into a higher range than in mid-2020, but we expect limited increases in the first half and all the pressure to be on the back end of the curve.
4. Valuations: Low yields and tight spreads will be constraining factors to returns in 2021.
- Key point: Credit spreads are sitting near typical cycle lows to begin the year.
- Bottom line for fixed income investors: As with all investment decisions, timing is key; a more aggressive, excess yield-driven posture may make more sense for the first half, giving way to a more defensive approach later in the 2021.
Credit Valuations Near Average Cycle Tights (valuations are option-adjusted spreads in bps)
5. Active management is key in a low-return environment.
- Key point: Expect above-index returns to be driven by generating excess yield with spread sector overweight, active curve management, and security selection.
- Bottom line for fixed income investors: 2021 is not an environment to be passive with fixed income allocations given index durations and yield levels.
*Source for all charts is Bloomberg.
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