Fiscal Spending and Bond Yields
December 30, 2020
Fiscal spending: The perception around fiscal spending has already begun to shift away from ‘more is better.’ We discussed this back in early October after a sell-side equity strategist argued the potential benefits of an estimated >$3T in incremental fiscal stimulus spending given a blue wave election scenario. At the time, we argued the required increase in Treasury issuance to pay for incremental spending of that magnitude would drive bond yields to problematic levels for equities. Without any incremental increase to fiscal spending, the FT estimates net new issuance of Treasuries notes will equal ~$1.8T in 2021 vs. -$500B in 2020 and ~$1T in 2018 and 2019. Holding demand constant, new bond supply should drive prices down/yields up. At some point, higher bond yields pressure equity multiples lower. And two of the last three equity market corrections started with a spike in bond yields.
Bond yields: At the moment, we expect bond yields to trace the arc of a gradual reopening process in H1’21. With the Fed on hold, we’re looking for the yield curve to steepen into mid-year, creating an environment where cyclical/value sectors (Industrials, Financials and Materials) outperform. Using the 5-year/30-year Treasury yield spread as a proxy for the yield curve, we see this ‘goldilocks’ spread environment in the ~130bps-140bps range. A spread greater than ~140bps would make Financials (banks) particularly attractive.