US election: what it means for fixed income markets

With Joe Biden being declared the winner of the US presidential race, how should fixed income investors be thinking about the risks and opportunities at this juncture?

03 dec 2020

Kevin Zhao, Head of Global Sovereign and Currency, Fixed Income

Kevin Zhao is the lead portfolio manager on all active Global Sovereign and Flexible Fixed Income Strategies as well as Active Currency Management. In this role he is responsible for all investment decisions taken for and implemented in these strategies. He is a member of the Fixed Income Investment Forum, and joined UBS Asset Management in 2011.

Have you made any significant changes to the UBS Global Dynamic Bond strategy given the outcome of the US election?

In the lead up to the November US election, we only made minor tactical adjustments while maintaining well diversified strategic positioning. We saw this as an event where we did not have an information advantage on how it would unfold politically. Therefore we preferred to wait for the election result before identifying key investment opportunities based on the expected economic policies from the new government and the new geopolitical landscape.

Of course, the UBS Global Dynamic Bond strategy is managed using a time tested, disciplined 4-step investment process of taking risks only when we see attractive reward opportunities with a thorough investment case.

Ultimately, this was a close presidential race and consensus expectations of a so-called “blue wave” failed to materialize. That said, in the aftermath of the elections, we found a compelling opportunity to add to our US rates position on market overreaction to the vaccine news.

Further, we increased our exposure to currencies that we believe should perform well in a risk on market environment such as the Australian dollar and emerging market (EM) currencies.

Specifically, the combination of a Biden win and positive COVID-19 vaccine news drove 10-year US Treasury yields close to the upper bound of what we deemed to be an attractive entry point. This was against the backdrop of the Fed expected to anchor short term rates for at least the next three years and a diminished chance of large fiscal stimulus.

Rates have rallied since we put on this position and we intend to trade this range tactically. Additionally, we added risk marginally across a variety of strategies as our outlook on the short term improved. For example we increased our allocation to corporates which we expect to benefit from continued spread tightening.

Further, we increased our exposure to currencies that we believe should perform well in a risk on market environment such as the Australian dollar and emerging market (EM) currencies. Finally we went from long to short positions in safe-haven currencies such as the Japanese yen.

Emerging markets are poised to be a beneficiary of a Biden administration. What does this mean for the UBS Global Dynamic Bond strategy’s exposure in these markets?

We generally agree that the outcome of the US elections should be supportive to risk assets, particularly EM, going into 2021. This of course is predicated on a number of important milestones including the ability of the new administration to be more integrationist, a successful rollout of COVID-19 vaccines and a more supportive global trading environment.

EM exposures within the UBS Global Dynamic Bond strategy are selective, comprised primarily of a diversified basket of hard currency bonds that provide a stable carry as well as a select number of local currency bonds from issuers with stable fundamentals and low inflation where central banks have room for policy easing.

We have held significant exposure to both local and hard currency EM bonds since the end of 2018. Back then we identified the peak of Fed funds rate, where the cutting cycle allowed EM central banks to be flexible with their monetary policy.

As always, our strategy will continue to emphasize the need to remain diversified across rates, credit and currency without unduly concentrating on one particular sector.

Going forward we do not anticipate any major changes to our EM positioning. However, we believe that we are well positioned to take advantage of any dislocations that may occur anywhere around the world should we experience sudden bouts of unexpected volatility over the coming months. As always, our strategy will continue to emphasize the need to remain diversified across rates, credit and currency without unduly concentrating on one particular sector.

Are there any major themes that will shape your strategy in Q1 2021?

The trend of persistently low yields on developed market bonds is one we expect to continue into 2021 with important implications for bond investors. In our recent publication of Panorama: Investing in 2021, we discussed structural drivers that will likely keep yields on developed market bond yields low for the foreseeable future.

While low levels of starting yields pose a challenge, they do not necessarily imply low total returns. One of the major benefits of our strategy is its ability to pull on multiple levers which aim to achieve attractive returns commensurate with our stated risk targets. As we enter 2021, we are focused on a balanced strategy that utilizes the flexibility we have in pursuit of our objectives. Our current strategy includes:

The trend of persistently low yields on developed market bonds is one we expect to continue into 2021 with important implications for bond investors.

  • Relative value trades within developed market government bonds, where we believe that certain markets have room to perform on a relative basis. One example is to stay long the US and New Zealand versus the UK.
  • Sensible allocation to diversified credit, where quality carry should remain supported by central banks' accommodative policies and could outperform on an excess return basis.
  • Allocation to emerging markets bonds where we have a favorable outlook. Our focus is on those central banks that have ample policy tools to support their economies. On the other hand we think Central and Eastern European central banks will face renewed inflation pressure and are likely to respond by tightening policies in 2022 or 2023. These economies which were already overheated prior to the COVID-19 shock benefitted from further aggressive easing during the lockdown. Consequently we see growth rebounding strongly in the coming years. In these markets we prefer short duration positions, where we think that yields are likely to rise.

Important legal information

To proceed, please confirm that you are a professional / qualified / institutional client and investor.

Views and opinions expressed are presented for informational purposes only and are a reflection of UBS Asset Management’s best judgment at the time a report or other content was compiled. UBS specifically prohibits the redistribution or reproduction of this material in whole or in part without the prior written permission of UBS and UBS accepts no liability whatsoever for the actions of third parties in this respect. The information and opinions contained in the content of this webpage have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith but no responsibility is accepted for any errors or omissions. All such information and opinions are subject to change without notice but any obligation to update or alter forward-looking statement as a result of new information, future events, or otherwise is disclaimed. Source for all data/charts, if not stated otherwise: UBS Asset Management.
Any market or investment views expressed are not intended to be investment research. Materials have not been prepared to address requirements designed to promote the independence of investment research and are not subject to any prohibition on dealing ahead of the dissemination of investment research. The information contained in this webpage does not constitute a distribution, nor should it be considered a recommendation to purchase or sell any particular security or fund. The materials and content provided will not constitute investment advice and should not be relied upon as the basis for investment decisions. As individual situations may differ, clients should seek independent professional tax, legal, accounting or other specialist advisors as to the legal and tax implication of investing. Plan fiduciaries should determine whether an investment program is prudent in light of a plan's own circumstances and overall portfolio. A number of the comments in the content of this webpage are considered forward-looking statements. Actual future results, however, may vary materially. Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss. 
© UBS 2021 The key symbol and UBS are among the registered and unregistered trademarks of UBS.

Reset

More about flexible fixed income investing

How can you navigate volatile fixed income markets and spot opportunities as they arise?

Latest fixed income insights

Asset Management services and solutions in your location

Please select your region

For further information on what we can offer you, please get in touch.