Given last week’s market activity, the Federal Reserve surprised the market on Sunday by cutting rates to roughly zero, re-extending quantitative easing (QE) and easing bank regulations to spur more lending. In this announcement, Powell acknowledged the government would now need to step up stating, “The thing that fiscal policy, and really only fiscal policy can do, is reach out directly to affected industries, affected workers, and we’ve seen some of that…In the meantime, the Fed will continue to use our tools to support the flow of credit.” The Fed has no desire to bring rates below zero given the unintended consequences that may have. The additional QE purchases of $500bn in Treasuries and $200bn in MBS are intended to ensure liquidity is not going to be an issue as the market grapples with this crisis.
Treasuries had another volatile week on the back of corona virus news and an expected fiscal stimulus package. Sunday’s Fed announcement has pushed yields back down this AM. The on-the-run Treasuries seem to be ‘social distancing’ themselves from one another, steepening the curve WoW, with 5 year and shorter maturities well-anchored.
Meanwhile, Corporate bond spreads have widened dramatically as earnings and refinancing risks grip the market. YTD US Corporate bond total returns have gone negative and under performed similar duration Treasuries by roughly 9%. These return levels have not been seen since the Global Financial Crisis and are unlikely to stabilize in the near term given the question marks surrounding the virus.
This week is about monitoring the progress of the authorities’ ability to cope with the spread of the virus in the US and abroad. The market is trying to digest the impact of the dramatic economic slowdown and weigh how long this will last. Fear of the US becoming the next ‘Italy’ seems justified as healthcare professionals continue to warn of the potential over extension of our healthcare system and the draconian measures needed to close borders and limit movement. The key factor is how quickly tests can be distributed and how fast the results can be processed. As progress in this area is made, it could potentially create a floor for the downside. Determining the likely probability of outcomes is tremendously difficult at this point so the best we can do is stay calm, be diligent and continue to wash our hands.
YTD Returns as of EOD Friday 03/09/20
US Barclays Agg +2.36%, 1.91% yield, – 303 bps excess returns
US Barclays Corp -1.88%, 3.18% yield, – 910 bps excess returns
UST 10yr 0.77% yield, -39 bps
S&P 500 2,711, -16.09%
DJIA 23,185, -18.76%
OIL (WTI) $31.15, -49.11%
Gold 1,530, +0.68%