By Robin Marshall, director, fixed income research, FTSE Russell
Long US Treasury yields backed up in advance of the US elections…
Longer dated US Treasury yields increased in October, in advance of the US elections, as Chart 1 shows. But US Treasury yields are still well below end-2019 levels, and long Bund yields remain near historic lows.
Chart 1: 20yr+ yields in US, Japan, WGBI, Germany and UK
…suggesting market concern about a major US fiscal reflation trade, should a “blue wave” emerge
The back-up in long yields means the US curve is as steep as it has been since COVID recession began, like the JGB curve, as Chart 2 shows, though this partly reflects the collapse in short yields, as central banks, resumed zero interest rate policy (ZIRP). The US Treasury market may have been concerned about a fiscal reflation, reminiscent of the Trump tax cuts in 2017/18, should the Democrats achieve a clean sweep of the White House and Congress, and increased debt supply as a result, although results to date suggest a clean sweep is now very unlikely.
But the COVID shock and US policy delay on a contested election result may limit steepening
Furthermore, US nominal GDP growth never accelerated substantially in 2017/18, and the COVID deflationary shock in 2020 have restricted curve steepening. Even with US rates at zero again, the 20yr+/1-3yr curve is no steeper in the US than in 2017, and 150bp flatter in Germany. Speculation about a major impact from the November US elections should be seen in the context of previous results since 2000, when the dominant influence on markets has been the economy and Fed policy. This is reinforced by the risk of policy delay, if the election result is contested, or gridlock results between President and Congress.
And Bund yields decoupled from the US, as the Eurozone experiences a 3rd deflation since 2008
Charts 1 and 2 also show the decoupling of longer dated Bund yields from the rise in yields elsewhere in the G7. The Eurozone is undergoing a third bout of outright deflation since 2008, as another COVID wave, a fragile financial system and low confidence weigh on recovery. Indeed, Bund yields now trade more than 50bp below JGB yields in long maturities, having traded above JGB yields as recently as mid-2019.
Chart 2: Yield curves in the US, Japan, WGBI, Germany and UK (20yr+ minus 1-3yr yields)
Source: FTSE Russell data as of Nov.2, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
Inflation breakevens tracked yield curve steepening but confirm the policy challenge from deflation
As Chart 3 shows, inflation breakevens are consistent with yield curve moves directionally since the COVID shock, rising as yield curves steepened, and central banks resumed QE, led by the US. But even in the US, inflation breakevens remain well below the 2% inflation target level, despite the Fed’s willingness to tolerate inflation above 2%. Increases in Eurozone and Japanese inflation breakevens also proved short-lived, after QE programs, reflecting the difficulty of reducing real interest rates when nominal interest rates are trapped at the effective lower bound. These factors suggest the G7 policy challenge from deflation remains substantial.
Chart 3: US, Japan, WGBI and French inflation breakevens
Source: FTSE Russell data as of November.2, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
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See FTSE Russell blog; US Presidential elections and market indexes – watch the economy, not outcomes, October 27, 2020
See FTSE Russell blog, https://www.ftserussell.com/blogs/trapped-below-zero-boj-and-deflation-risks, October 2020.
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