Coronavirus – Weekly update - 01/04/2020 - Investors' Corner

In this view, the unprecedented response in both scale and speed from the Fed and the U.S. government were…

  • March 3: First Fed ‘emergency cut’
    • Fed lowered the Fed Funds Rate range by 50 basis points to 1.00% – 1.25%
  • March 15: Sunday night surprise: Fed delivers massive package of monetary policy support:
    • Slashed the Fed Funds rate by 100 basis points bringing the target range to 0.0% to 0.25%
    • Announced a plan to purchase $700 billion of assets ($500 billion of Treasuries and $200 billion of mortgage backed securities (MBS))
    • Lowered the interest rate on excess reserves (IOER) to 0.10%; lowered the primary credit rate by 150 basis points to 0.25%
    • Increased the tenure banks can borrow at the discount window to 90 days and reduced the reserve requirement for many banks to zero
    • In coordination with the BOC, BOE, BOJ, ECB, and SNB, the Fed enhanced US dollar swap line arrangements to provide term liquidity to foreign central banks with US dollar operations
  • March 17,18: ECB & Fed announcements:
    • ECB: Pandemic Emergency Purchase Program (PEPP), which includes purchasing up to €750 billion ($820bn) in bonds this year across sovereign debt (including Greek bonds), corporate debt, and non-financial commercial paper
    • Fed announces Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), the Money Market Mutual Fund Liquidity Facility (MMLF)
  • March 23: Fed’s massive Monday announcement:
    • The Fed expanded quantitative easing (QE) from $700 billion to “the amount needed”
    • ‘Primary Market Corporate Credit Facility’ and ‘Secondary Market Corporate Credit Facility’ announced to buy corporate debt
    • Reinitiated Term Asset-Backed Securities Loan Facility and expanded MMLF and CPFF
  • March 27: Congress passes and President Trump signs CARES act
    • $2 trillion stimulus package includes direct payments and loans to individuals and businesses, allocates funds to state and local governments to cope with the crisis as well as direct spending on healthcare

Outlook and conclusions

The coronavirus and the measures taken to contain it have had a massive impact on individual lives, the economy and financial markets. While known to be large, significant uncertainty remains regarding just how dire the impacts will be.

  • Unemployment, which has been near 50 year lows, is expected to skyrocket. Some estimates, including from Fed members, project unemployment could increase to over 30%; this would be close to ten times the February 2020 rate of 3.5%
  • GDP growth is expected to plummet; many estimates for the impact to second quarter U.S. GDP are in the -20% to -40% range (on an annualized basis)
  • Corporate profits are now expected to drop precipitously; second quarter profits are expected to fall 10% year-over-year and full year 2020 profits, which had been expected to grow 9-10%, are now expected to decline by 1 – 2%.

In our view, the unprecedented response in both scale and speed from the Fed and the U.S. government were necessary to prevent further cascading of negative market sentiment in March, which itself could have led to more negative economic outcomes. In a similar fashion to how policy makers discuss ‘flattening the curve’ for the coronavirus to allow the healthcare system to deal with the sick, monetary and fiscal authorities effectively ‘flattened the curve’ of economic impact through the enormous measures undertaken to provide market liquidity and confidence. Nonetheless, while Wall Street may be (at least temporarily) placated, there is real pain to come for Main Street.  Job losses are likely to be extreme and have lingering impacts. The likely horrific second quarter GDP figures will not be released until the end of July, so hopefully the world will  be in a different place by the time the full impact is known.  In this way, markets may lead or be disconnected from what every day life feels like.  This is an important observation as we continue to live and work in a disrupted condition, but markets are already looking forward.

In December 2019 market update, was noted that “we view the risk of [credit spread] widening as asymmetric to the benefit of further tightening. As such, we remain cautious in terms of portfolio positioning regarding non-governmental exposure, but more comfortable with duration exposure.”  The de-risking that we had generally employed over the course of 2019 as spreads tightened has left us in a position to consider opportunities in the market today. At the current levels of credit spreads, levels reached in only extremely rare time periods, market results have historically demonstrated a strongly positive skew. 

While there is much uncertainty remaining, we expect and are positioning for outperformance from credit going forward, while acknowledging it is unlikely to be a smooth recovery as the world grapples with very serious health and economic conditions.