Yield Curves to Moderately Steepen in 2021

Tight liquidity could accelerate upward pressure on yieds

Fixed income securities have provided a ‘safer haven’ for investors in times of uncertainty. This was once again proven in 2020 when investors chose to overweight fixed income assets in response to the covid-19 induced shocks and uncertainty. 

The shift in capital towards fixed income was also encouraged by central banks’ unprecedented response to the crisis with record interest rate cuts and unparalleled bond purchases.

As 2020 winds down, news of a vaccine has seen a return of risky bets, albeit cautiously. 

The partial reopening of economies has resulted in a partial return of pre-crisis economic activity, reducing the urgency and quantum of additional stimulus from the monetary authorities.

Into 2020, therefore, gains on government securities may be rather modest. Indeed, central bank policies will keep short term yields anchored at low levels. 

However, long term yields may begin to modestly rise as anticipated economic recovery begin to fuel inflation expectations. The result should be a moderate steepening of governments’ yield curve in 2021.

Close home, the curve (+2 years) has steepened somewhat over the last three months as longer-dated yields rise faster than yields on the shorter end. Of course, T-bills have seen a steeper increase, causing some flattening at the very short end.

The steepening may be explained by the effects of higher fiscal deficits on the longer end of the curve and the dovish monetary policy guidance on the short end. Even then, it is worth noting that activity has been significantly muted on the short end and price discovery may not be very effective.

Into 2021, the upside from government securities could therefore decline markedly although the securities will remain a significant source of incomes to portfolios.

Moreover, sustained risk aversion coupled with limited investment alternative may still support liquidity and capital allocation towards bonds.

Local equities could recover from the 2020 troughs although the evident overexposure on Safaricom and banks as well as the broader balance sheet fragilities will limit capital allocations to the risky assets.

NCBA Research.
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