Fixed Income Outlook in 5 Charts | ETF Trends

1. Growth: Expect robust 2021 growth as conditions continue to normalize post-vaccine and policy remains accommodative.

  1. Key point: Larger fiscal stimulus expectations have begun to raise forecasts for growth.
  2. Bottom line for fixed income investors: Expect growth to keep upward pressure on rates, but also support spread levels.

2. Inflation: Higher growth and stimulus should cause an upward trend in inflation, but it is a slow process that typically takes years for an expansion to push inflation meaningfully higher.

  1. Key point: Inflation expectations have moved higher, as evidenced by TIPS, but the move is in-line with previous recoveries.
  2. 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.

  1. 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.
  2. 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.

  1. Key point: Credit spreads are sitting near typical cycle lows to begin the year.
  2. 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.

  1. Key point: Expect above-index returns to be driven by generating excess yield with spread sector overweight, active curve management, and security selection.
  2. 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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