- U.S. Treasury bond yields may trend slightly higher, lifted by expectations of additional fiscal spending.
- We have a relatively positive medium-term outlook for corporate credit.
- Vaccines may reduce mobility restrictions, but global economic recovery is likely to remain uneven.
Global financial markets trended higher during the fourth quarter, powered by the emergence of COVID-19 vaccines and continuing stimulus policies. Multiple coronavirus vaccines fueled hopes of returning to more normalcy in the economy, markets, and society as we move through 2021. But those gains and global economic recovery will depend on the rollout of coronavirus vaccines, corporate earnings, and the Federal Reserve's policy stance. The rate-sensitive Bloomberg Barclays U.S. Aggregate Bond Index advanced 0.67% during the quarter. The ICE BofA 1–3 Year U.S. Corporate Index rose 0.74%.
The Fed has pinned short-term interest rates near zero since March 2020. They also launched an array of lending programs and began large-scale purchases of government debt and mortgage securities. Central banks across Europe, Asia, and other regions also rolled out COVID-19 stimulus measures. In late December, the U.S. Congress approved a $900 billion pandemic relief package that would send direct payments to many Americans, provide aid to businesses, and fund distribution of vaccines, among other measures. This comes as COVID-19 cases began to surge in the United States. and globally, and some areas imposed new lockdown measures.
The U.S. Treasury yield curve moved higher and steepened somewhat during the period. The benchmark 10-year note finished the quarter at 0.93% from 1.88% at the beginning of 2020; the 2-year note yield fell to around 0.13% from 1.58%. Low yields on government debt have driven investors in search of better potential returns, including high-yield and investment-grade corporate bonds. We have a relatively positive medium-term outlook for corporate credit. Mortgage credit strategies also gained, supported by a strong housing market. Still, the commercial mortgage-backed securities (CMBS) market — especially retail and hospitality — face a challenging landscape due to the pandemic.
Fed extends lifeline with bond purchases
The Fed left short-term rates near zero at its December meeting and pledged to continue buying government-backed debt for the foreseeable future. Fed chair Jerome Powell said policy makers would keep their effort to bolster demand going "for some time," as they try to coax the economy back to full strength. The Fed has been buying $80 billion in Treasuries and $40 billion in mortgage bonds monthly since June and plans to maintain those purchases until there is progress in employment and inflation goals. We believe the central bank's backstop remains supportive for credit spreads. The Fed's efforts helped keep the yield on the 10-year Treasury note below 1% last quarter. But in early January, the 10-year yield rose above 1% for the first time since March, reflecting increased bets on additional fiscal spending in Washington.
The new pandemic relief package should help bridge the gap for consumers and businesses. President Trump signed the $900 billion stimulus bill into law on December 27. It casts a wide net with a variety of measures aimed at addressing the needs of millions of Americans. We also believe double-digit quarterly GDP growth is possible in late 2021 if vaccine developments stay on track and there are widespread immunizations. The Fed expects the economy to grow 4.2% this year and 3.2% in 2022, and the unemployment rate to fall to 5.0% this year. Still, consumer confidence unexpectedly fell in December to a four-month low amid surging COVID-19 cases and state-imposed mobility restrictions. Against this backdrop, hiring gains cooled in December. The jobless rate held steady at 6.7% from its April peak of 14.8%, a Labor Department report said.
ECB steps up cocktail of relief measures
Many parts of Europe face the threat of a double-dip recession because of rising virus cases, new restrictions, and slower consumer and business spending. Growth slipped back into contraction in the last three months of 2020 and is likely stay weak or even negative in the first quarter of 2021, in our view. Germany, France, the United Kingdom, and other countries have tightened or extended lockdowns. Germany, the region's largest economy, expanded a record 8.2% in the third quarter, fueled by private consumption, equipment investment, and a strong pickup in exports.
The European Central Bank (ECB) unleased new stimulus measures in December for the 19-nation eurozone economy. It extended its emergency bond-buying program by 500 billion euros and plans to provide new ultracheap loans for banks. The move brings the ECB's asset-buying program to 1.8 trillion euros and its total monetary stimulus to more than 3 trillion euros in 2020. The ECB extended its program by nine months to March 2022. The region's fixed-income markets received a major boost from the news. The borrowing costs of heavily indebted nations like Italy and Spain have fallen. Yields on Italian government debt, the riskiest among the eurozone's economies, hovered near multi-year lows.
China's economy defies the odds
China's economy is rebounding even as other major economies continue to struggle with the pandemic. The government has been largely successful in containing COVID-19, has embarked on an aggressive vaccination drive, and has stepped up stimulus measures. The economy grew 4.9% in the third quarter of 2020 from a year earlier after expanding 3.2% in the second quarter. Recovery has been widespread, including exports, private sector investment, and manufacturing. But consumer spending has been relatively subdued. China has rolled out a raft of stimulus measures, including tax relief and cuts in banks' reserve requirements.
The People's Bank of China has also provided extra liquidity in the market to contain rising bond yields. In November, there were a series of defaults involving state-owned companies in China — normally a safe pick for investors. Still, bond investors looking for yield have turned to Chinese government bonds since their yields are higher than U.S. or European yields. The benchmark 10-year bond yielded around 3.2%. The yuan also strengthened against the dollar last year, and the central bank has been trying to slow the appreciation.