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December 2020 | GSAM Connect

Fixed Income Outlook: Navigating the Status Low

The Macro Backdrop

Economic activity has rebounded but we have yet to cross the growth recovery line. A reorientation of the macro policy mix and green investments could create a cyclically strong expansion that generates inflation but we are not there yet.

The Policy Picture

Central banks will maintain the policy rate “status low,” while modulating asset purchases to maintain easy financial conditions. At the same time, the fiscal impulse is set to remain relatively friendly.

Navigating the Status Low

We will enter 2021 with low policy rates, low government bond yields and low fixed income spreads. To navigate this “status low,” we seek to access and diversify across the broad fixed income opportunity set including corporate and securitized credit alongside emerging market (EM) debt. We also look for openings to capture risk premiums created by market inefficiencies; locating these will be important as vaccine-driven cyclical improvements alongside a friendly policy mix creates a risk-on environment where potential return opportunities can swiftly evaporate. We also see value in utilizing currencies as a hedge for risk asset exposures. Last but by no means least, we advocate a sustained focus on environmental, social and governance (ESG) analysis, which 2020 has emphasized is a “bear market necessity” not just a “bull market luxury.”

What to Watch

  • The Pandemic. Scientific discovery has provided an exit route from the pandemic, but as recently discussed with a health expert during our daily investor Forum, vaccinations will entail “an unprecedented requirement for cooperation, coordination, synchronization and integration.”
  • The Macro. Potential downside growth risks include health setbacks alongside subdued demand as households and businesses constrain activity in order to shrink debt accumulated in 2020. Bankruptcies and defaults could also trend higher as forbearance draws to a close. We are also mindful of policy hiccups. Modest US fiscal stimulus or a premature pivot away from policy support as the cyclical backdrop improves could generate financial market volatility. Through 2021, we will be closely monitoring inflation expectations and labor market improvements in order to gauge whether less accommodative policy rhetoric is more ‘bark than bite’. 
  • The Markets. In a world of compressed risk premiums and rapid change, the implication for investors is simple: don’t blink. We believe steering risk sentiment with speed will drive alpha. A constrained opportunity set can result in attractive investment openings swiftly closing during bouts of risk-on investor sentiment, with crowded positioning dampening return potential. Meanwhile, risk-off episodes may present selective buying opportunities.

Related Insights

The Recovery Line

This summer was meant to commemorate the opening of the Olympics in Tokyo, but instead marked the reopening of economies globally. The policy backdrop remains supportive and we remain overweight fixed income sectors in the path of central bank buying.

Inflation – Are We There Yet?

Will the COVID-19 pandemic drive us into a higher inflation regime? This is a key unresolved question facing investors. In this publication GSAM economists discuss potential reflationary developments and disinflationary factors.

Capturing COVID-19 Risk Premiums

In March, the US market experienced a sharper sell off relative to Europe for two key reasons.

ESG Amplified

The COVID-19 pandemic has amplified the investment materiality of environmental, social and governance (ESG) factors. In particular, the COVID-19 crisis has shined a spotlight on companies’ social response—the ‘S’ in ESG—toward employees, customers, suppliers and society at large. In our view, companies that manage ESG risks well will be better equipped and more resilient in managing through the current environment and to survive future challenges.

Don't Blink

The COVID-19 pandemic, much like the global financial crisis, is a catalyst for change. If the global financial crisis created a “new normal”, the coronavirus outbreak has ushered in a time of rapid change. Welcome to the Great Acceleration.