Themes That Have Dominated the Markets to Date: Monetary and Fiscal Policy and, of Course, the Virus

U.S. Political Landscape

As we enter November, investors have used newfound clarity surrounding the U.S political landscape after a contentious presidential election, with an apparent winner in Joe Biden, as a reason to forget a mostly miserable October. Also, as Republicans look most likely to retain control of the Senate, fears of possible corporate and personal tax hikes associated with a Democratic “blue wave” have been pushed to the back burner. An additional booster shot has been provided by exciting late-stage vaccine trial data from Pfizer. Risk assets have been on a tear as we progress into November and the risk-off, or rather COVID-on mode, that ruled in the final weeks of October has been cast off, for now.

Fixed Income Markets: For October, Credit in Particular, Was a Port in the Storm

With vaccine hopes filling the air, it is easy to forget that October was the second consecutive down month for many risk assets. Virus cases surged around the globe in a ferocious wave that forced several European countries to reimpose restrictions on their citizens. The new lockdowns 2.0 in the U.K, France, Germany, Belgium, and Italy, among others, were a serious blow to what has been seen as progress in terms of global demand coming back. Ongoing political gridlock in Washington’s stimulus debates hardly helped matters with investor nervousness widespread and on full display, culminating in a late month reminder of the liquidity crisis experienced in March as everything went for sale. Stocks cratered, gold fell, and Treasury yields rose. Ultimately, the DJIA closed out October with a 4.6% loss, the S&P 500 and the Nasdaq fell 2.8% and 2.3%, respectively, and the VIX spiked to four-month highs, breaking above 40. The credit markets were resilient and well-behaved in the face of broad-based anxiety. Loans in particular were a port in the storm during the two-week period of heightened volatility and market weakness, outperforming bonds and equities. However, the loan market did slightly lag high yield in full month returns, providing a 0.18% gain while high yield bonds increased 0.51%.

Fixed income markets seemed intent on looking past the grim new stage of the pandemic. Treasury yields crept higher throughout the month, rising above 80 basis points for the first time since June and reaching as high as 92 basis points by election day. This is something yields have stubbornly refused to do until now, despite the long-ago recovery of stocks to pre-COVID highs. It certainly was not all bad news out there, at least on the economic front. U.S. October manufacturing surveys soared to two-year highs in a welcome sign of growing business confidence. The unemployment data released in the month showed that although job growth slowed in September, it still outperformed the Federal Reserve’s forecasts, hinting at a V-shaped recovery. But perhaps a more likely reason for the curve steepening was the belief that regardless of the winner of the presidential election, more fiscal stimulus would be coming and that the Federal Reserve would continue to support financial markets and overall system liquidity, leaving Chairman Jerome Powell as the most important person in the room, oval shaped or otherwise.  

Yield Levels Anchored by the Federal Reserve will Keep Investors Searching for Income

With this year’s big risk event out of the way, investors have begun focusing on the coming investing environment. Many unknowns remain, and questions surrounding the coming January Senatorial runoffs in Georgia, composition of a Biden Cabinet, and the size and timing of the next fiscal bill will continue to linger for some time. However, we believe that the themes that have dominated the markets to date, namely monetary and fiscal policy and, of course, the virus, will continue to be the focus in the months to come. Vaccine progress will certainly be a big sentiment driver though the recent progress has given us a glimpse to some certainty that one will be available for mass distribution sooner than many predicted. With an expected split U.S. government, the main elements of Biden’s policy platform such as, tax rate increases, a financial transaction tax, and a public healthcare option will be difficult to achieve, further normalizing volatility premiums. Yield levels anchored by the Federal Reserve will keep investors searching for income, a trend that has persisted for a while now. Overall, these conditions are broadly supportive of the credit markets, especially non-traditional income generating assets that will continue to find a permanent place in investor portfolios.