April 08, 2020
In a webinar recorded on April 1, 2020, Macquarie Fixed Income team members examined the extraordinary effects on fixed income markets in the face of the global pandemic, including macro factors and key priorities such as fiscal and monetary policy responses.
Bond market macro factor: Declining yields. The bond market was early to price in uncertainty, responding with inverted yield curves throughout 2019. In early 2020, with a widening divergence between stocks (represented by the S&P 500® Index) and 10-year US Treasurys, the bond market was sending signals of complacency even before the virus found its way to the United States.
Sector weakness further exposed markets during a black swan event. While stable growth was observed in the developed world in the last year, the manufacturing component arguably had been in recession since the Global Purchasing Managers’ Indices (PMI) moved into contraction territory in May 2019 for several months. With manufacturing on less stable footing, the global economy has been leveraged in many ways to consumers and the service sector, leaving markets vulnerable to a black swan event like the pandemic.
Consumers under pressure. In the US, the services component of gross domestic product (GDP) is about to be severely tested as the labor picture deteriorates meaningfully. US Federal Reserve officials have indicated that the US should anticipate the unemployment rate to rise to 10% or more. Even so, consumer confidence numbers have cooled but not collapsed, perhaps indicating that the general population has not come around to the potential economic and lifestyle changes that lie ahead.
Three key priorities. With this backdrop of market and economic reaction, three key priorities stand out to us as necessary to address the pandemic in the US and arguably globally:
- A clear understanding of the healthcare response – becoming clearer but more clarity required.
- Fiscal response – More than $2.7 trillion of stimulus in the US, or 12.7% of GDP, has been passed but not yet found its way into the economy.
- Monetary policy response – Liquidity injections by the Fed have been rapid and significant in scope.
Collapsing oil prices another black swan event. The recent precipitous drop in oil prices, triggered by increases in production due to a price war between Russia and Saudi Arabia is an example of how geopolitics has the capacity to turn markets upside down. While a sharp drop in oil prices might normally be viewed as an economic windfall, the pandemic is curtailing or canceling air travel, conferences, and more. Furthermore, capital expenditure budgets in the sector are being slashed. The sector requires close watching as oil producing countries attempt to settle their differences at a time when demand is eroding.
The Fed is all in. The Fed has taken aggressive steps to stabilize and address market dislocations, including unlimited quantitative easing (QE) and the rapid implementation of several liquidity programs targeting specific asset classes. Just in the month of March, the Fed stepped in and purchased nearly $100 billion of securities per day, which resulted in its balance sheet growing by more than $1 trillion. We should expect the central bank to continue to expand its balance sheet to $10 trillion or more, the equivalent of 50% of the country’s GDP. With the US running deficits comparable to 15-20% of GDP, the Fed’s purchases will play a key role in absorbing the additional Treasury supply, in our view; however, we should also recognize that these purchases will likely continue to distort asset prices.
Can the impact on the markets be contained? Since the global financial crisis, central banks have reacted to volatility with monetary policies such as QE to try to “contain” the markets. The current pandemic crisis is putting this approach to the test and is driving secondary risk factors such as recession fears and job losses higher. Extreme actions by monetary and fiscal policy makers are arguably vital to fighting the economic woes left in the virus’s wake. However, these steps are only part of the solution in our view. As such, we remain focused on liquidity and have been very patient and selective in deploying capital to dislocated segments of the market, focusing on issuers and issues that we believe are equipped to withstand a severe economic downturn and remain a going concern on the other side of the pandemic.