While record-setting prices for riskier assets hint at better days ahead, Portfolio Manager Nick Maroutsos believes that a complete exit from the pandemic may take longer than expected, justifying continued monetary and fiscal hyper-accommodation.

  Key takeaways

  • Weak economic data and ill-fated vaccine rollouts likely mean that a return to normalcy may be further out than what is priced into buoyant corporate bonds and equities.
  • Although a steepening Treasuries yield curve implies optimism, we believe that the US economy will require continued generous monetary and fiscal accommodation – something it is likely to find with the alliance between Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen.
  • With prices across riskier assets elevated and Treasury yields still miniscule, investors will likely have to get creative to access a level of diversification one typically expects from a bond allocation.


The past few months have seen several developments that have the potential to impact the investment landscape. A change of administration in Washington, control of the legislative branch passing to the Democrats, and in Europe, the finalisation of the UK’s exit from the European Union will all have policy and market ramifications. Yet these events are overshadowed by the persistence of the COVID-19 pandemic and the forceful response by major central banks.

Riskier assets have rallied on the approval of multiple vaccines. This signals that we are likely closer to the end than the beginning of the pandemic. As evidenced by missteps in the vaccine rollout, however, we believe the “return to normality” may be longer than expected. And once we arrive, investors will learn that “normal” will be different as consumer and business behaviour has likely permanently changed.

Despite market optimism, the choppiness that is likely to characterise the exit from the pandemic is already on display. Economic data in the US softened towards the end of the year and the UK has again issued stay-at-home orders to combat a new strain of the virus. The timing could not be worse as UK businesses face the additional burden of complying with a new trade regime with Europe. Still, the cloud of Brexit uncertainty has cleared, and the worst-case scenario was avoided.

Within the US, a change in administration typically means policy shifts that stand to reshape the economic landscape. While that is certainly true for this transition, we believe that any initiatives by the Biden administration will be overshadowed by the massive sway the US Federal Reserve (Fed) continues to hold over the country’s economic and financial market prospects.

Fed Chairman Jerome Powell is likely to find a willing partner in maintaining accommodative policy as his predecessor, Janet Yellen, assumes the helm of the Treasury Department. With this nomination, we believe the Fed’s longstanding call for more fiscal accommodation could finally be met, and the Powell-Yellen alliance could lead to an unprecedented level of cooperation between the Fed and the Treasury. Near-term stimulus is likely needed until the economy can safely reopen, but even after that we believe dovish policy will be on order for longer than many expect. This persistent level of economic support is likely behind the recent steepening of the Treasury curve.

We do not view the recent rise in longer-dated Treasury yields as worrisome. After all, they portend the expectation of economic growth. Furthermore, the Fed has made it known that it will not tolerate much higher rates. As the economy normalises, we expect the Fed is willing to accept modestly higher yields, but would move quickly to quell an acceleration in a Treasury sell-off. While Yield-Curve Control remains on the table, we expect that global differentials will keep a lid on yields as foreign investors would reallocate towards Treasuries to capitalise on yield differentials. A similar development may occur domestically as higher Treasury yields provide an alternative to riskier asset classes for income-focused investors.

Elevated valuations in both Treasuries and riskier assets lead many to question whether bonds would offer their traditional diversification benefits in the event of an equities sell-off. Given that we see many sources of risk, we share those concerns. With not much room to rally, we see little benefit in investors holding longer-dated Treasuries, especially as bonds are the asset class most at risk of a faster-than-expected economic normalisation.

The potential for diversification exists, but bond investors must likely travel further afield to achieve it. Several developed countries offer yields similar to Treasuries, but due to economic conditions may be quicker to cut policy rates than would the Fed.

Yield: The level of income on a security, typically expressed as a percentage rate. For a bond, the simple yield is calculated as the coupon payment divided by the current bond price.

Yield curve: The yield curve plots the yield of bonds with varying maturities, from short to long. Generally, long-term bonds pay higher yields. The curve steepens when the difference in yield on long-term bonds increases versus short-term bonds.