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SystematicEdge Monthly Market Overview February 2021

03 March 2021

MARKET CONTEXT: The rise in long-term interest rates is marking the start of a new economic cycle

Global Macro: As the world is recovering from the pandemic amid the deployment of vaccines, long-term interest rates have been rising around the globe. Governments’ massive money printing has increased the global supply of long-term government debt, which sold off in February. On the other hand, we expect governments’ stimulus packages to underpin a reflationary recovery in 2021 and 2022, which will be supportive to the Equity market. As a result, investors are requiring a higher risk premium to hold bonds from the oversupplied government bond market. The 10-year yield exceeded 1.50% in the US and Australia during the month of February while remaining close to 0% in Europe. However, these levels are not compelling enough to make investors switch from Equity and Credit to government bonds. Central banks have firmly anchored short-term rates at ultra-low levels around the world, with the US Fed fund rate at 0.07%, the ECB deposit rate at -0.50%, and the BoJ policy rate at -0.10%. In addition, governments with ballooning debt cannot afford to see their long-term borrowing costs soar. Central banks thus reiterated in February that they will continue to resort to “yield curve control” to keep a lid on their borrowing costs by maintaining their bond purchasing programs. As such, we expect long-term government rates to be capped at 2.5% in the US and 1.5% in the Eurozone in the coming years, while consumers’ continued quest for lower prices – underpinned by the rapid development of companies like Amazon and Uber – and the growing awareness of energy consumption efficiency maintain downward pressure on inflation. 

Financial Markets: Equity markets declined at the end of the month as rising bond yields raised concerns about growth stock valuations. The 10-year US Treasury yield jumped by as much as 37bps in February to end the month at 1.46%, representing an increase of 54bps year to date. Although the performance of regional equity indices was flattish in February, the sectorial rotation continued as stocks with high P/E (price-to-earnings) ratios, such as Tech stocks, sold off given the sensitivity of their valuation to interest rates while low P/E stocks, such as financials, rallied thanks to their resilience to rising interest rates. As the progressive exit from the pandemic points to a reflationary economic recovery, commodities rose sharply in February with oil prices surging close to 20%. We believe the rise in long-term interest rates and commodity prices, combined with the sectorial rotation of the equity markets, is marking the start of a new economic cycle, characterized by a strong post-pandemic economic rebound in 2021 and 2022.

Equity: Month to date the S&P 500 gained 3.0%, Euro Stoxx 50 +4.5%, Hang Seng +2.5% despite a clear sell-off at the end of the month triggered by rising long-term interest rates. Fixed Income: The 10-year US yield rose 37bps in February to 1.46%. As a result, Emerging Market government bonds declined 3.8% in USD and 3.3% in local currencies. High-yield corporate bonds edged up 0.5% in EUR and remained unchanged in USD. Currencies: The USD appreciated with respect to most major currencies, underpinned by the rise in long-term interest rates: EUR -0.4%, CNY -0.7%, AUD +0.8%; safe haven JPY -1.8%, CHF -2.0%. Commodities: Oil prices continued to rise in February while gold prices further contracted: WTI Oil +18.3%, Gold -6.3%.

Risks: In this new market regime and early phase of a new economic cycle, we have identified the following major risks:

Opportunities: