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As the coronavirus-induced economic dislocation becomes more profound, Nick Maroutsos, Co-Head of Global Bonds, discusses positioning within the Absolute Return Income Strategy.
Key takeaways
After weeks of deflecting coronavirus (COVID-19) concerns, country after country is beginning to shut down in an attempt to combat the threat of the virus to their populations. Markets have reacted fiercely in March, causing equities to sell off and pushing the yield on ‘safe haven’ 10-year US Treasuries to record lows. Government and central banks are being forced to introduce critical/extreme measures as they attempt to offset what may be a major global economic downturn. We expect that governments and central banks will do even more to support the system in due course.
Given these extraordinary circumstances, financial markets are likely to remain volatile and risk sentiment weak, reflecting both the public health threat and the economic uncertainty. The only macroeconomic data that sufficiently covers the period since concerns began had been limited mostly to earnings revisions, temporary store and business closures across Asia, and the ripple effect of supply chain disruption. Data from China covering the Lunar New Year lockdown, however, made for uncomfortable reading with industrial output declining a record 13.5% and retail sales down by more than 20% in the first two months of 2020. This has been compounded by the collapse in oil prices to around US$30 per barrel after Russia failed to reach agreement with OPEC on production cuts and Saudi Arabia subsequently announced it would boost production and cut prices.
Markets are acknowledging that shutdowns of whole swathes of the economy across multiple countries will mean a serious hit to gross domestic product figures, not just within individual countries but at a global level. Within the space of a few days, the debate has moved away from whether there will be a recession to the extent of its severity.
With interest rates near the zero bound, our base case is that there is little rates ammunition left for the Fed to use. Hence, we expect to see more quantitative easing and further stimulus in the form of fiscal policy. The measures announced mid-March by governments, with fiscal support equating to as much as 15% of GDP in the UK, begin to address the seriousness of the situation but whether even these measures are sufficient will depend on the longevity of the changed circumstances in which we all find ourselves.
While it is difficult to predict the duration of the coronavirus pandemic, an economic and market recovery is likely to occur against a backdrop of low rates, no inflation and ample stimulus. We are, however, in extraordinary times so parallels with recent downturns may no longer be valid. No-one can say for certain whether containment of the virus will be a success worldwide or how long the economic disruption will be in place. This reduced visibility means markets are likely to remain volatile, in our view, so we take some comfort from our defensive stance.