The screws are tightening, with Western countries taking ever more stringent measures to try to slow the spread of the Covid-19 pandemic. In a number of countries including France, Spain and Italy, the public authorities have imposed a lockdown. The borders around the European Union (EU) and the Schengen area are also about to be closed.
The global economy is taking a double hit from the pandemic. Initially, there was a negative supply shock and reduced production capacity, with businesses at a standstill and forced to postpone investment due to a lack of visibility. It is now clear that the lockdown measures will deal a damaging blow to demand. The closure of public spaces such as restaurants, cinemas, bars and the like will be reflected in much lower consumption figures, and this impact is expected to be visible from the second quarter of 2020.
reducing its key interest rates to 0%, entering into repo transactions of up to USD 500 billion, launching a new wave of quantitative easing worth USD 700 billion, announcing private-sector asset repurchases and entering into swap agreements with other central banks in developed countries in order to meet foreign demand for dollars.
The aim of all these measures is to provide the financial system with the liquidity it needs to prevent the kind of panic seen during the major financial crisis of 2008. As a result, assuming they prove effective and yield spreads start to fall again, the global economy should get back on its feet once the peak of the pandemic is behind us.
Governments are also marshalling enormous resources to counter the economic slowdown, including in the US, where the Trump administration has ordered a budgetary intervention worth USD 1.000 billion, or nearly 5% of US GDP. The most remarkable part of this announcement was undoubtedly the plan to send US citizens at least a quarter of this amount in USD 1.000 cheques – a step that the authorities might even take twice.
Europe too announced measures which, although less eye-catching, were still highly ambitious. Such stimulus policies include loan guarantees for businesses, benefits for affected employees and the postponement of tax and social security payments. By way of example, Germany is about to make EUR 500 billion available to businesses via state-owned development bank KfW, and France is preparing to guarantee bank loans to businesses to the tune of EUR 300 billion.
It has to be acknowledged that this pandemic has most likely tipped the global economy into recession. However, the monetary and budgetary policies that have been put in place are highly ambitious and have lifted our spirits, especially if the peak of the epidemic is reached rapidly.
Market movements in recent days have been a constant reflection of investor uncertainty as regards the development of the Covid-19 pandemic. Investors appear to be finding it difficult to position themselves, torn between the attractiveness of current market valuations and fear of the future impact of the pandemic on the economy and the financial health of companies.
A phase of relative calm and consolidation could emerge, however, with strong budgetary/fiscal stimulus measures announced by the main governments in Europe and the US, and the central banks restarting their respective quantitative easing programmes and undertaking to maintain adequate levels of liquidity in the money and interbank markets.
As an example, France has launched a support package worth EUR 45 billion for companies and employees, with measures that include postponing the payment of all social security contributions and taxes owed by businesses. The public deficit is expected to jump to 3,9% of GDP. In the UK, Boris Johnson plans to introduce a stimulus package worth GBP 330 billion, i.e. 15% of GDP, in the form of government-guaranteed business loans on attractive terms. Lastly, on 18 March the US voted in favour of a stimulus budget worth USD 850 billion.
In the equity markets, more specifically, massive widespread sell-offs gradually gave way to clearer investment strategies. Gold companies are actually picking up and the Utilities sector is resuming its defensive character. Likewise, the patterns seen previously in the impact of Covid-19 on different sectors now appear to be providing solid bases for guiding investment decisions. Shopping centres, non-essential retail and tourism operators are suffering, while producers and distributors of staple food items and cleaning products are performing relatively well. A word of warning, though: the roles could be reversed when things pick up, as the sectors that are currently suffering include some high-quality businesses. In similar fashion, companies with low levels of debt are showing less sensitivity to the bad health and macroeconomic news.
Last week’s decisions by a number of central banks had a substantial impact on the bond markets.
In Europe, the ECB was unable to provide reassurance. While it increased its asset purchase programme by EUR 120 billion over the year and strengthened its TLTRO policy, the markets were expecting more. In this regard, no rate reduction has been announced and the stance taken by Christine Lagarde, the President of the ECB, puzzled investors. Sovereign rates rose significantly as a result, with Italy out ahead. Movements in excess of 60 basis points were seen on Thursday alone and private debt risk premiums followed in their wake.
One week later, the institution made a further announcement which calmed the markets. The ECB is committing to making additional purchases worth EUR 750 billion in 2020 under its asset purchase programme. This new announcement was directly beneficial to Italian rates and therefore our positioning. With rates close to those seen in May 2019, when the country was plunged into deep political and budget instability, our view is that Italian debt is a worthwhile investment at current levels. Political stability is better today than in the past, the ECB is continuing to provide support and the rapid spread of coronavirus in Italy will not drive the country to default.
On the other side of the pond, the Fed also remains highly accommodative, reducing its rates last Sunday for the second time this month and moving them into the 0-0,25% range. At the same time, it announced the purchase of at least USD 500 million of US treasury bills and USD 200 billion of mortgage-backed securities.
The effects of these announcements could be seen on Monday, when the equities market fell sharply and US sovereign rates nosedived. Additionally, the central banks (the Fed, ECB, BoE, BoJ, Bank of Canada and Swiss National Bank) moved in harmony to improve market liquidity, including through permanent USD swap agreements.
The Fed also announced the purchase of private-sector commercial paper for around USD 10 billion.
Despite the scope of these measures, risk premiums on private debt followed the same upwards trajectory as in the previous week, while sovereign rates increased in Europe and fell in the US. We think that European credit is now at an attractive level for non-cyclical companies such as those we already hold in the portfolio. We are monitoring the situation closely, along with developments in companies that would not present too high a credit risk in the current environment. In the US, our positioning on the curve benefited significantly from the coronavirus crisis. We are maintaining a positive stance on short rates at present but staying aligned along the rest of the curve.
Although clearly impacted by these shocks, our investments are standing up much better than the reference indices thanks to their largely resilient sector exposure and recent timely adjustments, such as the sharp reduction in high-yield bonds. While there remains still a great deal of uncertainty, especially around the actual economic impact, we note that a large number of assets have been sold at prices unrelated to their actual valuation, and we encourage investors to build positions as soon as the capital markets begin to display more measured responses.
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