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What’s In Store for Fixed Income?

November 24, 2020

Editor’s note: Any and all references to time frames longer than one trading day are for purposes of market context only, and not recommendations of any holding time frame. Daily rebalancing ETFs are not meant to be held unmonitored for long periods. If you don't have the resources, time or inclination to constantly monitor and manage your positions, leveraged and inverse ETFs are not for you.

The election is behind us (hopefully), and a vaccine for COVID-19 seems imminent. But these huge question marks have created another one: what is in store for bonds?

For the better part of the past six years, the U.S. Dollar has maintained its reputation as a powerhouse in the currency markets, retaining a relative index value of well over 90 against a basket of other currencies that include the Euro, the British Pound, and Japanese Yen.

Even now, in the depths of a global pandemic that has kneecapped businesses across the country and the world, the ICE U.S. Dollar Index puts the greenback at a relative index value in the low-90s.

Although this is by no means low, it is certainly lower than where it spent much of 2018 and 2019. This discounted rate is a result of the extremely accommodative policy approach of the Federal Reserve, which has dropped interest rates to near-zero levels and expanded its balance sheet by buying up fixed income assets in an attempt to preserve liquidity.

This approach has helped buoy asset prices and provided stability to the private sector. But it has also resulted in the lower relative value of the USD we see today while also opening the door for inflation should that weakness persist.

This, in turn, has cut into the real issue here: the values of U.S. Treasurys, which have fallen as a result of the aggressive policies implemented by the Fed and prompted renewed strength in two of Direxion’s bearish fixed income ETFs.

A Swift Reversal

Since August, the price of U.S. bonds and treasury notes has receded alongside the drop in the dollar’s value. This has boosted Direxion’s most popular bearish fixed income leveraged ETFs. The Direxion Daily 7-10 Year Treasury Bear 3X Shares ETF (TYO) and the Direxion Daily 20+ Year Treasury Bear 3X Shares ETF (TMV) have each risen by 7% and nearly 31% over the previous three months.

That recent downtrend stands in stark contrast to the trajectory of fixed income assets through the majority of 2020, which have been in high demand as increased economic uncertainty pushed investors toward the stability of U.S.-issued debt. Until recently, fixed-income investments have surged as other currencies labored under stagnant economic growth.

This can be seen in TYO’s and TMV’s bullish counterparts, the Direxion Daily 7-10 Year Treasury Bull 3X Shares ETF (TYD) and the Direxion Daily 20+ Year Treasury Bull 3X Shares ETF (TMF). Despite falling 7% and 24% respectively over the preceding three months, TYD and TMF remain higher by 24% and 29% year-to-date.

The recent reversal, coupled with a rally in stocks, sets the stage for an interesting economic question: will falling fixed-income assets, increased demand for U.S. equities push inflationary trends higher, or will discounted treasury prices encourage greater hedging as investors prepare for more uncertainty?

It is, unfortunately, a question with no clear answer.

Federal Reserve Chairman Jerome Powell has heavily signaled that the central bank’s policy at the moment is to maintain the stability of the nation’s private sector and wait for more fiscal stimulus from Congress. It’s an approach that has seen some positive results, bolstering stocks and allowing for easier borrowing among businesses and consumers. And now that we’re past the election, another round of aid from Congress seems likely.

Of course, since the Fed’s dedication to maintaining liquidity is the foundation of its strategy of setting up a quick economic recovery, there remains the risk of a continued devaluation of the dollar if the country continues to struggle.

Overall, while the bears may have taken hold of the fixed-income market for the moment, those truly worried about the stability of their investments are still likely to see U.S. debt as a hedge against the potential of volatility around the world as we bid farewell to a chaotic 2020 and look ahead to a slightly less (hopefully) uncertain future.

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