This Time, It’s Different
2020 has been an eventful year to say the least, with the COVID-19 pandemic dragging the global economy into its deepest recession since the Great Depression and impacting virtually all sectors of activity. Although bonds delivered great performance and diversification over the year amid significant monetary easing, fixed income markets have had their fair share of obstacles (read Challenged Liquidity: Bond Pricing in Stressed Markets). One very important lesson from 2020 to keep in mind as we move into 2021 is that markets can change rapidly and investors can unconsciously fall into the trap of the Confirmation Bias – a mental mistake that can be very detrimental to longterm portfolio returns.
The path for bond markets in 2021 seems clearly visible at first, with most portfolio managers and economists (including ourselves) arguing that rates will stay low and range-bound while credit markets will remain well-supported thanks to the stimulus put in place by central banks and governments. However, as we’re only at the early stage of an unprecedented economic recovery and with investors lining up on the same side of the trade, it will be critical to seek concrete evidence that would give us an idea of how the economy is truly doing, allowing us to adjust our positioning accordingly, rather than following the herd.
Increased stability requires increased vigilance
This crisis is most likely far from over and we will almost certainly see additional bouts of volatility, but the main reason many investors tend to agree on the general direction of fixed income markets in 2021 (i.e. relatively stable rates and credit spreads) is because of the massive response from governments and central banks to tackle the COVID-19 pandemic. This has significant impacts on the economy and financial markets as key rates are not expected to be raised anytime soon while the market expects additional stimulus should the situation deteriorate.
The COVID-19 crisis is certainly being taken seriously, with governments and central banks using all the tools at their disposal to help their respective economies navigate this extremely difficult period – measures that have also resulted in healthier and more stable financial markets. Globally, fiscal responses (such as temporary tax cuts, loans, and capital injections) have amounted to $11.7 trillion or close to 12% of global GDP¹, while central banks have cut interest rates to historic lows and committed trillions in monetary stimulus, including targeted quantitative easing programs to support less-liquid segments of the debt market. As a percentage of GDP, this coordinated global fiscal response has far exceeded the measures launched during the Global Financial Crisis of 2008.