Short & Intermediate Duration Fixed Income: Q3 2020 Themes, Outlook & Strategy

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Short & Intermediate Duration Fixed Income

PUBLIC FIXED INCOME

Short & Intermediate Duration Fixed Income: Q3 2020 Themes, Outlook & Strategy

Jun. 30, 2020
  • Stimulus Measures — Despite stimulus and support measures to support markets and encourage economic growth, we are not in the “V-shaped” recovery camp. Growth headwinds may persist, with re-openings delayed until a Covid-19 vaccine or therapy becomes available. Trade tensions with China and the EU may also re-emerge. U.S. real GDP growth should rebound in the second half of 2020, but full recovery could take several years. 
  • Consumer — Confidence has rebounded but sits well below pre-pandemic levels. Spending has been supported by the CARES Act, enhanced unemployment benefits, mortgage forbearance as well as rent and installment payment holidays. The CARES Act has boosted real personal income, but consumers have focused on non-discretionary purchases. The jump in the savings rate suggests that discretionary spending may improve. 
  • Employment — Unemployment has improved but will likely remain high. Migration of workers from temporarily to permanently unemployed will likely weigh on the labor market. The ratio of unemployed workers to job openings spiked to over 4x from below 1x.1 Social distancing may persist, hurting certain sectors — lodging, leisure, restaurants, transportation/travel, and retail. Work-from-home policies could also reshape the labor market. 
  • Business — Small and midsize businesses continue to grapple with staffing and reopening. Declining revenues, higher costs and margin pressure, weakened credit metrics, and changes in business models are widespread. Downward ratings pressure and a higher default rate are likely despite significant monetary and fiscal measures. 
  • Central Banks — Monetary and Fiscal Policy - Central banks are likely to remain accommodative, and fiscal stimulus should continue. The Fed seems poised to maintain liquidity, backstop markets, and ensure access to borrowing. The Fed has pushed back against the idea of negative rates; it will focus on forward guidance before shifting to any yield curve control. Another fiscal package is expected in the U.S. before the August recess. 
  • November Election — Renewed spread of Covid-19 in Red states could impact political races. In the event of a Democratic sweep, a number of changes are likely: expansion of the Affordable Care Act, a public health option, changes in energy policy, growth in infrastructure spending, a rise in the minimum wage, a rollback of regulatory reforms, and higher taxes. For corporations, tax-reduced cash flows and profits could be worsened by higher labor costs. 
  • Residential / Commercial Real Estate — Policy responses have blunted the impact of the pandemic. Low single-digit home price growth is supported by low mortgage rates and tight inventories. Mortgage originators are increasing capacity and adapting to Covid-19. Competitive mortgage rates and rising prepayments are likely to persist. As forbearance programs phase out, delinquencies will increase. Retail and lodging metrics appear to be bottoming out, but trust delinquencies will likely rise as data comes in. Low inventories of single-family homes and rentals have supported multi-family properties. Office properties continue to face challenges from work-from-home trends. 
  • Inflation — Expectations in the U.S. have risen, driven by the surge in the money supply and a rebound in energy prices. Trimmed mean measures of inflation are much higher than recent core inflation prints. It may be difficult for the Fed to achieve its 2% target as labor market slack could persist. With higher prices due to on-shored manufacturing, a weaker dollar, and huge fiscal and monetary stimulus, inflation could tick up.