10 year Gilts, it seems incredible to say, ended the week more or less unchanged at 37bps. In the meantime the FTSE 100 lost over a 1000 points or around 17%. It might not seem like the most stunning event of the week but the inability of rates markets (risk free) to rally – or act as a hedge to equity holdings ( risk markets) may have the most profound implications for investments. This is not to belittle the exceptional UK rate cut on Wednesday, the impact of the most expansive budge in a generation nor indeed the human toll of the Coronavirus and its knock on implications.
The slowing down of the Global economy is now a fact. The impacts will now be measured in units of severity rather than uncertainty. The EU now see GDP contracting by 1%. The UK’s forecast of positive 1.1% growth for 2020 very much looks like last week’s news. Evidently, there are sectors that will take the full brunt of major economies going into “curfew”. Travel and hospitality sectors are the most obvious but the knock on effect on banks is already being felt in valuations in credit markets. Both the ECB and the Bank of England are seeking to provide reassurance to the plumbing of the banking system and provide support to those effected, small and medium sized entities through loans and loan support. SME and larger companies can benefit from the cash flooding the system. Everywhere, prudential safety buffers have been removed to allow more cash to flow to the real economy. This is good news but there will always be concerns about the detail.
Credit markets –sandwiched between equity and rates markets had a compellingly fearful week. A simple measure of credit risk would be a frequently traded index of weaker credits (Crossover). This ended the week 1.5% higher in yield. Many high yield credit bonds fared worse than this with the oil sector particularly hard hit. With a slump of 1/3 in the value of oil occurring at Monday’s open many bonds fell dramatically in price between 10 and 30 points. Much like the relationship with Gilts and the FTSE the relationship between cash bonds and Indices became very confusing making tried and tested risk management techniques obsolete.
Much has been done by authorities to soften the blow of the virus. Expect more. We debate timelines but what was once set to effect Q1 will impact certainly H1 and clearly the whole of 2020. Markets like to describe future outcomes in letters: V (swift bounce back), U (it will recover after a while) or L (we’re down here for a long while). At the end of this week, even with Friday’s bounce back in equities a U would be the best of it and credit markets believe “down here for a long while” is a real possibility. We have had no week quite like this since 2008. There is so much new information to digest. Much has been thrown up in the air and it will not all land back in the same place.