The major battle ahead for markets
November delivered a lot of reasons to be optimistic for the future ahead, with multiple vaccines announced, a settled US election and a democratic-republican spit between control. However, fixed income investors should be watching the major battle ahead - that 2021 optimism versus the Federal Reserve.
In this month's market review, I argue that it is likely that the Fed will extend the duration of their bond purchases and keep yields low for the time being. Unless volatility begins to increase, the outlook remains consistent with what we have seen for the last few months. We expect the RBA to expand their QE program and despite some volatility in the coming months, to continue with their edict of low rates across the board.
Well, what an extraordinary month, starting with the US selection and the election of President Biden, but probably with a Republican Senate, which will make it very restrictive for him to implement any material agenda. There is still a runoff in those Senate seats in Georgia, which won't be until early January, but at this stage, it looks like the Republicans will hold. And it does mean if that is the way that we'll move forward, we'll have a much smaller fiscal stimulus programme and a lot of the financial repression, which we've come to understand since the GFC, will remain. The Federal Reserve will be the major game in town, and investors will follow the Federal Reserve very closely and the usage of the Federal Reserve's balance sheet.
Of course, throughout November, we had multiple positive vaccine stories, which is wonderful, wonderful news. It's definitely generated a lot of optimism for 2021, that these can come to market. I certainly hope that, coming through what is now this Northern Hemisphere winter, we can get through that. And then once the vaccines are available, say by Q2 or Q3, hopefully we could say goodbye to COVID once and for all.
The major battle that the markets and in the fixed income space are dealing with at the moment is that optimism for 2021 versus the Federal Reserve. And we know full well, after 10 years since the GFC, that it doesn't pay to fight the Federal Reserve. And it is very likely that the Fed will extend the duration of their bond purchases programme in order to keep bond yields very low and make sure that governments and all corporates and the like can borrow very cheaply at very low yields.
We have a big meeting coming up later on in December, in the middle of the month. And there'll be huge anticipation for that moment, but the game theory of it almost dictates that we must see some volatility to incentivise the Fed to ultimately deliver. Whether it's in December or early next year, we firmly believe that they will deliver such a programme, and very likely here in Australia, that we'll see a much larger extension of the QE programme, and the RBA already openly talking about that.
So in many respects, as much as we'll see some volatility likely in the months ahead, we don't expect that materially will change in valuation a tremendous amount, other than just oscillating around within a range, as we've really done in the Australian market for most of this year, since April. And we would expect that that range could probably widen a little bit, but ultimately, it's not going very far, by virtue of the RBA edict, which is to keep bond yields very low for federal government bonds, state, government bonds, corporations and individuals, in order to help prime whatever recovery we can gain out of this 2020 year.
It's been an extraordinary year. And I just want thank you all for following and wish you all the very best for the festive season. With working from home, a lot of us haven't had much of a break this year. It's been nonstop, and certainly we're all looking forward to spending some time with our families and recharging the batteries for a big 2021.
Thank you very much.
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Charles is a co-founder of Jamieson Coote Bonds (JCB) and oversees portfolio management of the Australian and Global High Grade Bond and Dynamic Alpha investment strategies. Prior to JCB, Charles forged a career as a seasoned bond investor from...