Esty Dwek, Head of Global Market Strategy en Natixis IM Solutions says there are strong stress signal in the credit market but she still things systemic risk is still low.
What has happened?
Stimulus packages keep rolling in, and keep getting bigger. Treasury Secretary Mnuchin is discussing a USD1.2 trillion package (6% of GDP), Spain talked about EUR200 billion, France EUR500 billion and combined with other Eurozone countries the equivalent of 8.5% of EZ GDP, the UK GBP330 billion (15% of GDP) and Japan USD190 billion.
Showing both how seriously it is taking the situation and that it is not out of ammunition, the Fed announced further measures to shore up funding and credit markets. It will set up a special-purpose vehicle to buy commercial paper to help with short-term funding pressures, though stress in that market has continued to rise, as concerns over businesses’ short-term ability to repay this paper is in question. The Fed also announced a Primary Dealer Credit Facility offering overnight and term funding for up to 90 days to ease the liquidity strain, both with the backing of the Treasury.
Yesterday, markets had a somewhat quieter day and advanced on stimulus announcements, though concerns over the short-term recession and default risk have pushed futures back into negative territory this morning (~3-5%). The S&P500 was up 6% while European markets were up around 3%. US Treasury yields rose with US markets, with the 10-year breaching 1% again. In Germany, 10-year Bunds are yielding -0.43% and Italian 10-year still widening to 2.17%.
Credit spreads and credit default swaps continue to rise indiscriminately – past 2015 levels – as investors worry about waves of defaults, despite central bank and government support.
Travel restrictions and confinement measures continue to rise as Europe issued a travel ban and most developed countries are now asking citizens to stay home. With businesses stopped or closed, unemployment is on the rise already, and incoming data is likely to start to show the impact on growth in the coming days and weeks.
Until we see cases peaking in Europe and the US, markets will remain under pressure. In addition, markets have yet to price in the full impact on earnings, which will need to be downgraded further. So while valuations have dropped, they have further to fall still. These are clearly much better entry points for the longer term, but it is still too early to add risk back to portfolios.
What are you watching?
We continue to monitor containment efforts, as more countries are following China’s lead (sort of), but fiscal support is what is most needed to reassure markets.
We will closely look at high-frequency data to see how the European and US economies are evolving, to see if any signs of sharp deterioration – especially in the US – should change our medium-term outlook. We already know March data will be poor, as will April, and the impact can continue beyond that.
We also are looking at credit and funding markets, where signs of stress have started to rise. For now, systemic risks remain low and the Fed is doing what is needed to prevent a credit crisis.