Taxes, Treasuries and taper on the mind
Three things to watch in 2021.
The success of widespread coronavirus vaccination is the most important factor to watch in 2021, in order to restore pre-coronavirus levels of employment and GDP. If vaccination falls short—perhaps due to inadequate take-up by the public or disappointing effectiveness—constructive economic outlooks for this year will be off the mark. Assuming vaccination is successful, below are three things to watch in fixed income.
- Fiscal policy and taxes The Democratic Party will have control of the White House and both houses of Congress. Voting margins are tight on Capitol Hill, but legislative procedures related to the budget likely will allow President Biden to increase the top marginal tax rate back to 39.6%, push the corporate tax rate to 25% and increase capital gains tax rates. Higher tax rates should support strong demand for tax-exempt municipal bonds and may alter investor behavior with respect to recently high-flying risk assets, perhaps prompting investors to take gains before tax rates rise.
- Taper Tantrum 2.0? The Federal Reserve set off an undesirable spike in U.S. Treasury yields in 2013 when Fed Chair Bernanke floated the idea of tapering its bond purchases amid an accelerating economic expansion. Are we in for another taper tantrum in 2021? We don’t think so, as we believe the Fed will not see “sufficient progress” toward its employment and inflation goals to justify a 2021 taper. That said, the Fed’s recent forward guidance on asset purchases may be too vague to avoid market speculation of a near-term taper and may need to be refined.
- Treasury yields With Fed target rates at zero, no taper and some moderate upward drift in inflation as the U.S. economy “normalizes” amid vaccination and fiscal expansion, expect Treasury yields to rise. We anticipate that the 10-year Treasury yield will finish the year around 1.50%.