While Covid-19 continues to spread across the US, neither the stock market nor the yield curve are signalling a material slowdown. Cyclical stocks continue to outperform defensive sectors. The yield curve is comfortably positively slopped.
Both reflect the optimism towards vaccines and belief that any near-term downside risks will be offset by renewed monetary and fiscal support.
Chart 11: US yield curve steepening
Over the past year, two-year real yields have fallen in 13 of 19 emerging markets, with the Philippines (down 344 bps) and Mexico (down 333 bps) exhibiting the fastest pace of decline. By comparison, just six economies have seen two-year real yields rise over the past year, with China (up 362 bps) witnessing the greatest increase among EM peers.
More than developed markets, emerging markets have been relying on monetary policy to stimulate growth. Of the 247 rate cuts this year, just 17 came from developed market central banks.
Chart 12: Change in 2-year teal yields (bpts)
The rally in US credit markets has been led by the lowest rated (CCC) bonds. This reflects the decision by the US Federal Reserve to purchase lower grade bonds as part of its quantitative easing program.
In a rare public disagreement, U.S. Treasury Secretary Mnuchin requested that emergency Fed stimulus programs be allowed to expire as scheduled on Dec. 31. Fed Chair Powell immediately objected to the instruction.
Market participants had expected another extension given the economic impact of a recent surge in COVID-19 cases. The measures had helped everything from junk to high-grade debt rally since the spring, reversing one of the worst sell-offs since the GFC.
Chart 13: US credit rally lead by CCC rated bonds (Index: 04/08/20=100)