Bond Yields Perking Up In The Opening Days Of 2021

We are very much concerned that prospects for bi-partisan legislative accomplishments may be subject to delay given the out-sized political morass, yet we are not anticipating irreparable damage to the prospects for open negotiations. Given a greater emphasis on shepherding the recovery to a stronger trajectory, a new Biden administration may delay individual tax hikes as a way to preserve consumer engagement. While elevating the corporate tax rate may come first, we are not convinced that it will necessarily move up to as high as 28% given the need to advance corporate recovery and profits and given potential resistance from some of the more moderate Democrats. We speculate that funding allocations for highways, bridges, tunnels and airports now have a higher probability of being made. Again, we can reasonably expect to see a greater application of P3 financing which could relieve material burdens upon those local governments in particular struggling to recover from severe revenue dislocation. The roll-out narrative for the multiple COVID-19 vaccines has taken on greater urgency given mounting evidence of uneven distribution and access with noted bottlenecks altogether.

The opening days of 2021 have shown a willingness of bond yields to move decidedly higher, as the 10-year UST benchmark Yield moved above 1% for the first time since the third week of March last year. The recent advance to higher bond yields can be associated with growth expectations, but perhaps more closely to pressing inflationary concerns. We have to realize that normal inflation has to be part of the recovery process, especially with so much excess economic capacity, and there is no need to think that a death knell to fixed income bond valuations is upon us. We are not anticipating inflation to catalyze a breakout shift in Fed policy at this time, and we think there is quite a way to go before our sentiment changes. For now, inflation should have a diminutive impact on the financial markets and any producer/consumer price advances may pressure yields higher as the economy loosens up with further fiscal relief and the roll-out of COVID-19 vaccines. Higher inflation may possibly be viewed as a sign of economic confidence with perhaps wages achieving further advances and with an accelerated return to pre-pandemic GDP. In our view, the Fed is more concerned with the elevated COVID-19 transmission rates than with inflation inputs, although the Central Bank recognizes select areas of rising demand and that inflation comes back faster in some areas than others, particularly where supply disruption has been most apparent. Here the question becomes just how transient will inflation be?

The Central Bank acknowledges uneven economic recovery throughout the country and has indicated an openness to above 2% inflation for a time being, but protracted price advances could result in a shift in monetary policy and bond investors should pay attention to the steepness of the Treasury yield curve when making inflation bets. Curve steepener expectations would likely be impacted by prospects for additional liquidity intervention and spending initiatives. For now, if inflation moves beyond 2% let’s temper our reaction. A hotter run of inflation would be welcome for a while, but the last thing we want is stagflation where growth does not move in tandem. As for currently higher bond yields here in the U.S., which can also be reflective of UST supply pressure, we have to believe that still-present negative or zero interest rates abroad may limit their upside potential as foreign demand for UST will likely persist throughout 2021. We believe that curve behavior in 2021 will be more influenced by growth and inflation prospects than by Fed policy, and for now yields are not necessarily poised to attain pre-pandemic levels. Early convictions in the Treasury market were enough to lessen the social distancing with Munis, with tax-exempt yields being escorted higher. However, despite the price weakness, we have witnessed continued out-performance given a favorable technical environment.

For a comprehensive portfolio evaluation of your municipal holdings, please contact your Oppenheimer Financial Professional.