The Vaccine is Giving the Bond Market a Reaction

We are now more than a year past when the pandemic started and everyone wants a clear picture of the future. When will things return to normal? When everyone’s focused on the future, it’s easy to ignore or miss what is happening right in front of us. Recent COVID-19 data is showing some incredible progress:

COVID-19 hospitalizations are down approximately 60% from their peak in early January

• COVID-19 new cases have fallen approximately 75% from their peak in early January

• COVID-19 daily deaths are down approximately 45% from their peak in early January

Over 13% of Americans have now received at least one dose of the Pfizer/Moderna vaccine. Older Americans are being vaccinated at much higher rates which is very important because the virus has been particularly fatal for older men and women. Americans age 75 and older represent only 6% of the population but 60% of all COVID-19 deaths and over 80% of all COVID-19 deaths have come from Americans over the age of 64. This is why we were very excited to read that 64% of Americans age 75 and older and nearly half of those 64 have already been given at least 1 dose of the vaccine. As for the vaccines, the limiting factor remains supply, but we’ll soon see a significant increase as just this past weekend the FDA approved the Johnson & Johnson vaccine for emergency use. J&J says it will be able to produce 20 million doses by the end of March and 100 million by the end of June. And as the J&J vaccine only requires a single dose, this will mean an additional 100 million people that can be vaccinated within the next 4 months (J&J Phase 3 trials showed 85% effectiveness against severe disease and zero cases of hospitalization or death 28 days post-vaccination). This should continue to push down hospitalizations and deaths in the coming weeks and months. We hope that the road back to normal is finally within sight. Grandparents can safely hug their grandkids again; weddings, birthdays and graduations can be celebrated; humans can start being humans again. That’s something we should all be celebrating.

However, good news regarding the virus has led to a reaction from the Bond market. When investors think about investing in bonds, losing money isn’t the first thing that comes to mind. Bonds tend to be synonymous with safety and while that is often the case, often is not always. Over the past 40 years, interest rates largely moved in one direction: down. The 10 year Treasury went from a yield of 15.84% in 1981 to an all-time closing low of 0.52% in 2020. This move down has been great for bond investors as prices move inversely to yields. But that was the past. What has been a tailwind for decades (falling rates) could now become a major headwind. The 10 year Treasury yield began the year at 0.92% and has risen to as high as 1.53% over the past few days. What could cause bond yields to continue to rise from here? Interestingly, continued good news on the virus front could lead to bad news for bond investors in the following ways:

1. Rising inflation. Inflation expectations are at their highest levels in years. Interest rates tend to be highly correlated with rates of inflation. You are seeing increased inflation at the gas pump.

2. Rising supply. The US National Debt has increased approximately $4.5 trillion in the last year to nearly $28 trillion. It is expected to go even higher with the passage of a $900 billion stimulus bill in late December and another $1.5 - $2 trillion bill likely coming next month. More stimulus means more debt which means more government bonds issued. Increase in supply could put upward pressure on rates.

3. Rising Growth Rates. Stimulus & the release of pent-up demand in certain sectors of the economy as we return to some normalcy could lead to very high growth rates. We are seeing 2021 GDP estimates in the 5 – 6% range which would be the highest the US has seen since the early ’80s.

If we know that rates are a headwind for bond returns, does that mean we shouldn’t own any bonds? We believe the answer is no. We believe that bonds still provide diversification benefits, specifically as a diversifier from stocks. Bonds still provide portfolio income, and will provide more income as rates rise. If you sell your bonds and add to other asset classes like stocks, real estate, or commodities, you could be dramatically increasing your overall portfolio risk. Different types of bonds react to rising rates in different ways. Some bonds are more sensitive to rising rates than others. It will be our job to navigate a rising rate environment for our clients. One way we will do this is by reducing exposure to things like long-term bonds (which are very sensitive to rising rates) and focusing on a broader array of bonds for diversification. Bottom Line: Good news regarding the virus is leading to higher interest rates because the economic outlook is improving. This is good news in a lot of ways, but creates challenges for bond investments. As always, feel free to reach out to your advisor if you would like to discuss your investments or your financial plan.

- Brett