15th March 2020

🗞️ No FOMO for Us – Only Fear

iTraxx Main

111.5bp, -16bp

iTraxx X-Over

526.8bp, -62.4bp

🇩🇪 10 Yr Bund

-0.58%, +16bp

iBoxx Corp IG

B+188bp, +2bp

iBoxx Corp HY

B+661bp, +10bp

🇺🇸 10 Yr US T-Bond

0.98%, +13bp

🇬🇧 FTSE 100 [wp_live_scraper id=”17″], [wp_live_scraper id=”24″] 🇩🇪 DAX [wp_live_scraper id=”19″], [wp_live_scraper id=”25″] 🇺🇸 S&P 500 [wp_live_scraper id=”21″], [wp_live_scraper id=”26″]

We’re all scientists now…

Judging by that equity market price action in the US (+9%), one would think that the markets were convinced that monetary and fiscal easing are the cure for Covid-19. That was some melt-up. It had ‘fear of missing out’ written all over it. This week it will just be ‘fear’.

The investment landscape is about to worsen – markedly. This is no time to get involved. There are going many more big dips ahead of us. Because, honestly, we just don’t know where this is going. The general response has been a hotchpotch of action trying to tackle the collapsed veins of the global economy and it failed, for example, with the monetary stimulus. More will come anyway.

If only to try and limit the macro damage – the stents are now going in, in a last throw of the die. The announcements initially by Germany and the EU (US state of emergency followed) of large scale fiscal remedy suggests it might keep the markets ticking over. How can it?

In the markets, equities are displaying the volatility reflective of each headline. Rates are finding themselves in some sort of no-mans-land. Credit has been battered with high yield and the CoCo market, year to date, are sitting on returns of around -11%. Spreads (iBoxx index) have gapped to B+661bp and B+844bp, respectively. As the global shut down accelerates and spreads, we are looking at B+1000bp and north of B+1500bp for those markets, respectively.

This is a health crisis which has been bereft of a globally coordinated response as the responsibility has fallen on individual governments. That’s unlike the 2008 financial crisis, where the action was more coordinated and decisive.

The high levels of uncertainty as governments respond in different ways (the concept of the nation-state is in/globalisation is out) and sporting events are cancelled, travel restrictions are extended and so on all have the world on hold. The consequences of it will be clearer once we emerge out the other side. There are likely going to be some major corporate casualties.

We think it’s too simple to believe that we will ride out the next several weeks and go into something resembling a V-shaped recovery, as the industrial machinery goes into turbo boost mode to meet the pent-up demand.

Because if the science is right, many countries will lack having built up a ‘herd immunity’ against the Covid-19, having locked down too soon before peak-virus. Thus we might see numerous supply/demand shocks as repeated ‘second wave’ coronavirus outbreaks emerge through the winter months, leaving markets exhibiting higher levels of volatility than otherwise might have been the case.

Not sure that it makes sense

So we had the huge equity market rally on Friday in the US. It will have been seen as a relief trade that the US administration might finally have started making better informed decisions. On this occasion, it was the declaration of a national emergency which ensured that greater levels of federal funds would be made available to help tackle the crisis.

The UK has since been put on a war footing (or will be according to reports) as the disease’s spread heads into the ‘exponential phase’. Apple has closed all of its stores outside of China. There are going to serious and large-scale corporate casualties (bankruptcies, lower earnings, job layoffs).

Economic growth is going to fall sharply and, in many cases, it will be catastrophic. Inflation, investment and sentiment will all plummet. The Fed will cut again and zero interest rates beckon. Eventually, we believe that the US will go into a greater level of lockdown across the nation.

The recovery in Friday’s session in Europe had earlier promised to be as euphoric as the decline previously, but we faded the gains and didn’t quite manage to hit the ball out of the park. The US did, but only after that Federal response, whence a national emergency was declared.

Given the deteriorating news flow over the weekend, we will most likely not follow when we open in Europe this week.

The Dax was up 9% at one stage in last week’s final session, and it closed 0.8% higher. The FTSE was also higher by a similar amount, only to close 2.5% higher.

The initial bounces higher came courtesy of a large fiscal response from Germany (including unlimited credit to cash-strapped companies), in the first instance. This was later followed through by the EU where we had the Commission’s new President’s own ‘whatever it takes’ message which was rammed home in English, French and German!

Bond market yields backed up (dash to cash?) in anticipation of a swathe of issuance, although how far they can go will be limited as the central banks will be hoovering up a fair chunk of them through expanded QE programmes. There’s also a natural increased demand for safe-haven, risk-free securities.

The benchmark 10-year yield in the US rose to 0.98% (+13bp) which was 67bp off the record low seen earlier in the week, while the record low 0.70% yield for the 30-year was 1.60% at Friday’s close! In Bunds, the yield rose to -0.58% (+16bp) and the Gilt to 0.41%.

Credit markets were not buying it and didn’t follow the trend in equities. IG cash, though, edged only a couple of basis points wider to B+188bp (iBoxx index) although that was 50bp wider in the week.

High beta bank risk took another battering, though. The sector is going to feel immense pain as lower rates affect profitability while loan losses and the like eat into capital buffers – and profits. The CoCo market is shell-shocked – Covid-19 ravaged, that is.

The AT1 index moved another 62bp wider on Friday which left it 325bp wider in the week, and investors sitting on considerable losses now, year to date. Total returns year to date are -11%, and any recovery in this market will not follow any bounce equities like for like – should they rise. The index spread has risen to B+844bp. That could easily double.

The corporate high yield market, also savaged of late, saw a more measured decline on Friday. That was understandable because any chance of macro stability and that will feed into the market immediately. Unfortunately, the worsening situation as evidenced over the weekend, and we must be looking at worst-case scenarios.

The HY index only widened by 10bp (to B+661bp) – 90bp wider in the week. HY returns year to date show losses of 10.4%. B+1000bp or worse is beginning to look like a target for the coming weeks.

We’re not expecting a bright opening on Monday. Following into that US rally might see a borrower or two chance their arms. Shell-shocked investors and traders alike will be nervous about what comes next.

Have a good day.

Suki Mann

A 30+ year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on CreditMarketDaily.com.