Weekly View - Black Thursday
Last week ushered in a rise in market dislocations. Correlations across different asset classes rose sharply on the back of funding issues, including a lack of dollar funding. Core government bonds, which had been bolstered by the recent risk-off sentiment, sold off alongside equities. We remain underweight European bonds as well as equities and believe that low leverage will outperform during periods of heightened market turmoil like we are in now. Meanwhile, the deflating oil price – hit now by both the demand and supply sides – continues to put pressure on lower-quality, high-yield bonds.
Policymakers have stepped up efforts to cushion a likely recession and avoid systemic risk. On Thursday, the European Central Bank announced a targeted response to the coronavirus outbreak by providing additional liquidity and setting TLTRO below the deposit rate, effectively giving free money to banks. For its part, the German government has pledged unlimited cash to businesses hit by the virus as it stands prepared to abandon its sacred Black Zero balanced-budget policy to help finance such measures. Spain will allocate 1.5% of its GDP to support efforts and Italy has also committed to supporting its small and mid-sized enterprises. And finally, the US Federal Reserve slashed rates and announced measures to boost market liquidity on Sunday. Synchronised monetary, fiscal and regulatory responses will pose the best chance at combatting today’s multiple headwinds and policymakers are being proactive on this.
Adding to the short-term economic pain, Europe is shutting down. Spain declared a state of emergency and France, following Italy’s example, closed all non-essential businesses over the weekend. Meanwhile the US has closed its borders to Europeans in its own attempts to contain the spread of the coronavirus. These measures will undoubtedly affect European growth, but we take heart from signs that the virus outbreak has peaked in the first areas hit in Italy. We will hopefully see the skies start to clear by mid-April. But we still need to see how deep and long recession is, with the recovery of activity in Asia is taking a bit longer than expected. Because of this, we remain underweight equities but are starting to look for opportunities— with a clear emphasis on liquidity and unleveraged companies.