Last week, we discussed the first risk we anticipate for next year: the potential shift in corporate behaviour on the back of funding rates at record lows. This week, we consider the risk that a taper tantrum could emerge in 2021.
Central banks have played a greater role in influencing valuations this year through their direct purchases. As a result, they have removed a significant amount of risk premia from markets – and not just the ones they are directly involved in.
Investors have become used to lower volatility – and achieving less of a premium – within the investment-grade market, which has been skewed by central-bank activity. Because of this, they have been willing to take on more risk in other parts of the market.
This resulted in a near-record amount of negative-yielding assets globally, record low yields across credit markets and a global high-yield cash price at a five-year high (see figure 1).
Figure 1. The global high-yield cash price shoots up
Source: ICE Bond Indices, as at December 2020.
As markets return to normality in 2021, central banks will have no option but to consider scaling back their programmes. With the market laser-focused on any hint that central banks are contemplating a withdrawal, volatility is all but unavoidable.
Switching on the monetary taps is easy and feels good for everyone involved, but a withdrawal of this helping hand can be just as painful. Sadly, it is also necessary evil. As a result, investors should think carefully about their fixed-income allocations and consider how a truly global and unconstrained approach could help them achieve their goals.