BNP Paribas: Investment Outlook 2021 - Legacy of the Lockdowns - Part 6

Major central banks will likely maintain policy rates near or below zero percent for several years. They have little choice but to fund the increases in budget deficits that have followed the lockdowns, monetising an expanding national debt, much as Japan has done. The European Central Bank has already made it very clear that in 2021 it intends to buy as many bonds as needed to prevent monetary conditions from tightening for all eurozone governments. Consequently, G3 sovereign debt markets are now driven to a worrying degree by technical factors.

The appropriate historical parallel is the post-World War II period, when central banks capped bond yields at levels well below the trend GDP growth rate to gradually reduce the national debt as a proportion of GDP. The implication is that government debt managers and central banks are likely to coordinate the maturity profiles of issuance and purchases to engineer low real yields over coming years. This argues for a structural long position, or at least a strategy to buy duration on any meaningful back-ups.

In such an environment, the search for yield in fixed income will likely underpin valuations in corporate debt markets. The primary concern for credit investors is to differentiate between those industries that will be permanently damaged by the pandemic and the lockdown recessions and those which are only temporarily out of favour. It is equally important to avoid those sectors whose prices have been bid up as investors seek out safe havens, but which are at risk of significant underperformance – primarily in the US – as the economy recovers and fiscal stimulus boosts growth and inflation expectations.

Investment Outlook 2021 - Legacy of the Lockdowns - Part 5