We still recommend exposure to moderate credit risk in an environment of stable but low government bond yields, massive fiscal stimulus and an increasingly bifurcated corporate landscape.
Corporate bonds are the single most important source of financing for the US corporate sector. Therefore, it has been of utmost importance for the Federal Reserve to keep the capital market open for the US borrowers. To this aim, the Fed has been working with the US Treasury and unveiled plans to found special purpose vehicles (SPVs), with capital from the latter and leverage from the former, to purchase corporate bonds, including exchange-traded funds and bonds of companies downgraded after the plan had been announced on 22 April this year. The strategy has been highly successful.
Even before a single bond has been bought, credit spreads of both investment-grade and speculative-grade bonds have narrowed and new issue volumes skyrocketed. March has seen the largest volume of new corporate bond issues in history in the US, and April could even top this record. What is lacking so far are details by when the SPVs will be operational, and whether or not the Fed applies some credit-spread targets with its purchases. The bond market is hoping for some clarity at today’s Fed press conference. We still regard the current spread level of Baa/BBB and Ba/BB-rated bonds as adequate to compensate for the expected credit losses in these segments but would refrain from investing in bonds with lower quality and/or sectors with structural problems such as retailers, media houses or energy companies.
Other than that, bond strategists are also keen to see whether Fed Chair Powell provides some hints on his Treasury purchase programme. After pledging unlimited support for the government, the Fed had initially bought as much as USD 75 billion of Treasury bonds per day in late March, but has slowed its pace considerably since then. This could be seen as a move towards a yield curve control, a strategy applied by the Federal Reserve during wartimes and also applied by the Bank of Japan since 2016. In an environment with collapsing consumer demand, a lack of corporate capital spending and deflationary angst, such a strategy would be easy to implement and contain volatility of bond yields. It remains to be seen whether Powell is ready for this step this month.
CHINA: EFFORTS TO SUPRESS 2ND WAVE SUCCESSFUL, ECONOMY STILL WEAK
We remain Overweight on China. Of the major world economies, it will be the least impacted by the coronavirus. It is impacted nonetheless, but China’s economies of scale, and financial and technological resources, mean it can develop “new infrastructure” even more than it had previously planned to. Our recommendation for long-term investors is to be positioned in that space, and all its ancillaries, while in the short-term, “old infrastructure” (like cement and construction equipment) will also receive a boost.
Yesterday, Beijing Xiaotangshan Hospital (designated for the treatment of suspected cases and confirmed mild cases) announced it had discharged its last remaining patients and will close today. This is a sign that the strong measures to prevent a second wave of imported and asymptomatic coronavirus cases from becoming a new pandemic are proving successful. Yet the country remains vigilant, and for good reason. All of yesterday’s 21 new confirmed cases were imported, all on an airplane arriving from overseas. Asymptomatic cases simmer along in the same low numbers, but are obviously more difficult to identify than overseas arrivals.
Caixin Media reported yesterday that a residual group of approximately 30 people in Wuhan are still testing positive after more than 20 days of treatment, and it is unclear if they can transmit the virus. For this reason, doctors at the Chinese Academy of Medical Sciences’ Institute of Pathogen Biology said yesterday it is likely that the coronavirus could become a seasonal illness, like influenza. Still, it can be said with some certitude that the second wave is miniscule relative to the size of the country’s population, and should come under control soon. Most political observers expect the date of the annual plenary sessions of the National People’s Congress and People’s Political Consultative Conference to be announced this week. These gatherings of 3,000 deputies and 2,000 members are where the policy agenda is set. Whether attendees make the trip to Beijing or the meetings are held via videoconference will be a barometer of sorts, of the way the coronavirus has impacted society.
High frequency data continues to show an uneven recovery. Subway usage has recovered in the prosperous southern provinces of Guangdong and Fujian, but nationwide, daily passenger traffic on public transport in the first 27 days of this month was still down by 59% y/y, a small improvement from the 64% drop in March. It appears that people who can afford to do so have been switching to private transport, with passenger car sales rising from -38% to -7.3% over the same period. Home sales in the 30 largest cities also improved from -38% to -20%, while power plant coal consumption improved from -20% to -13%. However, export orders in the April Emerging Industries Purchasing Managers´ Index fell 12 percentage points to a historical low, suggesting a large vacuum in external demand. It is therefore not surprising that at an executive meeting of the State Council held yesterday, related parties were instructed to accelerate “new infrastructure” like the industrial internet (used in manufacturing and energy management) and information networks, for further digital consumption.
Analysis from Julius Baer