The race between infections and injections

Charlie Jamieson

Jamieson Coote Bonds

The furore of the Australian Open outbreak highlighted the reality that COVID-19 may be here to stay, despite the widespread preparation for an uninterrupted 2021. In what seems like a lifetime ago, January was a pivotal period for bond markets driven by a blue wave through the US Senate, an ever-evolving Covid situation and sustained levels of stimulus. Virus mutations and the government's suppression approach to managing the disease could lead to further frustrations of economic output.

In this month's market review, I explore the implications of the Senate deadlock, with the likelihood of large-scale bond issuances placing pressure on bond yields. However, without a supermajority, their ability to pass sweeping legislation through the year is limited. Optimism appears to be the theme of 2021 brought on by sustained fiscal and monetary support. However, investors must be aware of the dangers of following the crowd, as this has produced immense volatility as of late. As the situation continues to progress, it appears this year's key Australian Open match-up is Injections versus Infections.

Watch the video below to hear my full insights for January 2021 and beyond. 


Transcript

Hi, I'm Charlie Jamieson, Chief Investment Officer at Jamieson Coote Bonds and this is a review of markets in January 2021.

The major story in markets across January was the blue wave. The Democrats taking control of the US Senate, winning both the Georgia runoff Senate seats, giving the Senate a deadlock at 50/50, where the Vice President can then cast the deciding vote to pass legislation.

It's interesting to talk about that because it's little spoken of in the media, that that process is called reconciliation, and it can only happen once a year. That's pretty important as it pertains to deficit spending in the United States. There's big expectation that the Democrats will spend a lot of money in response to COVID in particular. And clearly that means lots of US bonds to be issued, lots of supply, and that's putting pressure on bond yields at the moment. But that reconciliation process is worth exploring a little bit more because people often think that that gives the Democrats full control of this legislative passage, but it's only once a year on things, in particular, spending, on revenue and on debt limit ceilings.

So we do expect them to use it early on, but otherwise the Senate needs essentially a supermajority of 60 to stop senators using ‘the filibuster’, which is a Senate law which says senators can debate endlessly on the passage of legislation, essentially therefore choking up the Senate so nothing can happen. And so really you need a 60 out of 100 Senate majority to break that filibuster and get legislation passed.

So the blue wave, which obviously has vast implication for democratic legislative agenda, clearly there's a part of the Democratic Party which is very left, which wants to see things like the New Green Deal and the like, huge amounts of deficit spending come through the Senate, is unlikely to pass as easily. We get a one-time deal to probably do COVID relief. The number being bandied about is 1.9 trillion, a truly astonishing number, but clearly that leaves the US with lots and lots of bonds to issue, and unsurprisingly, has bond markets on the back foot as a result of that.

Of course, the reason that we're all talking about this still remains COVID. COVID is running rampant everywhere where winter is present at the moment in the Northern Hemisphere, and it really has become a race between infections versus injections. We know the vaccine rollout will certainly play a very big part in eradicating COVID, but there are mutations which are causing clearly some concern. This variant from the UK or from South Africa is clearly something that everybody is trying to avoid. And I find it interesting here that a lot of people are planning 2021 as if there's no interruption come the winter in Australia. I have to believe that given we've really gone for a suppression strategy, that we still remain very vulnerable. As much as we will be vaccinating those that are very exposed, the elderly, the frontline workers, I don't think that that's going to stop governments from slowing things down, frustrating economic output.

Should we get a little rise, as everyone is getting a rise in the winter months, we've got to assume that there are stop-starts like that coming up for our winter, particularly down here where I am in Melbourne, sadly. Today, the day that we're filming, we've had another outbreak from the Australian Open. And again, things are changing very quickly. There's a lot of uncertainty in our own business. We were planning to travel. That's all being thrown up in the air right now. So these kind of issues are going to remain and that's going to frustrate the economic recovery process over the course of 2021, we continue to believe.

What it does also probably mean is that we'll continue to get huge amounts of stimulus. Now, we know that the federal government have said that they want to wind down JobKeeper. That's listed to finish at the end of March, but there has been a huge step up in monetary support with another extension of the QE Programme. When the QE Programme was launched last November, remember the RBA said that they'd never go down this road, and now that they firmly went down, we commented at the time, very publicly, that this programme will be extended. And we still absolutely believe that to be the case.

It is very difficult to extract yourself from these types of programmes once they start. They do generate huge amounts of excess liquidity in the system. It's very, very good for markets, and markets are enjoying that, but just already this week, we've seen $100 billion extension of quantitative easing, which should be very supportive for risk assets, also for the bond market here in Australia. As much as the bond market at the moment is following US Treasury yields a little bit higher, what we generally find in those sell off periods is once the US Treasury market finds its feet, other markets that have been dragged along on that process tend to recover very quickly. And that's still our expectation for the Australian government bond market.

Under the second round of QE, which will actually take $1.5 billion of bonds out of circulation every week from April through to November. That's an extraordinary amount of what we call negative net supply. Certainly, different from the US experience where clearly this huge amounts of new bonds to issue, yields need to go higher to foster demand, to find buyers for those new securities. In Australia, we've got the absolute reverse. We're going to be taking product away from the market, leaving those natural participants less inventory in stock to fight over, and therefore it should be very supportive from a flow point of view. But that'll take a little time to wash through the system.

I guess we're already seeing over 2021, everybody is very optimistic. Clearly there has been huge fiscal support, huge monetary support. Economies in the Northern Hemisphere will come out of winter soon enough and they will be roaring to get going. A lot of people have been frustrated and locked up. They're eager to get out and spend. There have been supply blockages. There are prices for lots of things that are jumping around. Data is fairly volatile. But there are unintended consequences to all of this. We've seen some of that with the SoftBank episode over January, February, the very early parts of February. Again, where retail investors get together and squeeze short markets, causing long-short hedge funds that pre-sell things and own things on the other side to have a market neutral position. A lot of anxiety. And that did cause pretty substantial sell-off in equity markets for a period.

We continue to have these little episodes of volatility and they're becoming more frequent, whether that was the XIV volatility blow up, whether it was the rates backing up in the back part of 2018, causing equities to have a vertical downdraft. These types of episodes, clearly we saw lots of it last year, are continuing to happen. And we can see the system is really changing very quickly. There's capital flowing into all kinds of places. And there are a lot of excesses and there are a lot of crowded type positioning. So these things are likely to continue to occur. So we just make note of that, I guess. There does seem to be a very uniform narrative at the moment. And so for the contrarians amongst you, clearly, there can be opportunities in that over the course of time.

And interestingly, particularly if things get better, then it's hard to argue for this constant stimulus. And we do go into a bit of a fiscal cliff environment where the government steps back and the private sector needs to step forward. And at that point we think markets could look at that and not really love what they see over the hill. So absolutely worth considering.

We've written a big year ahead piece. If you'd like a copy of that, we're very happy to provide it to you. Please just contact either ourselves or the channel distribution guys and quote your investor reference number. We'll happily provide you with a copy of that, that maps out all of our expectations for bond markets over the course of the year, put some maths around some of that. We're very happy to explain some of the more technical elements, if you require that, but we'd love to have those conversations with you. Thank you very much

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Chief Investment Officer
Jamieson Coote Bonds

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...

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