Knowledge. Shared Blog

April 2020

Liquidity Crisis Begins to Heal

The coronavirus crisis continues to impact economies and markets, but the liquidity crisis is seemingly beginning to heal. Jenna Barnard, Co-Head of Strategic Fixed Income, shares her views on the latest developments.

Key Takeaways

  • Given the size, scale and breadth of asset class purchases central banks have embarked on, markets are beginning to heal. Last week, the investment-grade market reopened in style, with many high-quality, multinational corporates issuing new bonds with new issue premiums of typically 50 to 70 basis points.
  • We are likely to see high default rates in sectors where there is very little equity value, including companies that have struggled in good times such as energy, retail and some telecommunication companies in the U.S.
  • Post-crisis, prospects for government bonds seem binary: We anticipate either a Japanese playbook of anesthetizing the bond market via yield curve control or an inflationary boom driven by the coordinated fiscal and monetary response that has been unleashed.
View Transcript

Jenna Barnard: I wanted to provide a brief update for investors on what has been going on in credit markets and within our funds.

I think the first thing to note is the liquidity crisis is beginning to heal. So central banks were three to five days behind the curve. They have adopted numerous programs, and the size and scale and breadth of the asset classes they are buying is encouraging. The investment-grade market has reopened in style. We have seen record issuance in U.S. investment grade, bonds are coming to market very cheap with new issue premiums of as much as 50 to 70 basis points. Allocations are low, demand is very high, and these bonds have been rallying as much as five points on the break. So the market is beginning to heal.

It must be remembered that corporate bonds rank senior to equity. And I think the decision by European regulators to suspend banking dividends, equity dividends, is interesting in that respect. AT1 coupons, subordinated bond coupons, are still intact as we speak, and we expect rights issues or equity placings for active investors who want to support quality companies to bridge any liquidity issues over the next six to nine months.

Sectors where there is very little equity value, which is struggled in good times, like energy, like retail and some telcos in the U.S., we expect very high default rates. We don’t think equity investors or credit investors have the appetite to step into those sectors, those kind of zombie companies. But away from that in the high-yield market, you know, we are actually encouraged at? the lengths that governments are going to try and prevent defaults, keep corporates in operation. And a good example of that is the German government supporting, government KFW, the German industrial bank, lending to a company like TUI, a travel company, to keep it in business.

So we are very positive on investment-grade credit. We selectively like areas of high-yield market, but it’s going to wash around with equities and economic impact of this virus. And on government bonds, there’s really two scenarios here. There is either the Japanese playbook of anesthetizing the bond market via yield curve control and capping 10-year bond yields at certain levels. That’s the U.S. in the 1940s, Japan since 2016, and Australia last week went down that route for their three-year government bonds. The other alternative is an inflationary boom, driven by the coordinated fiscal and monetary response that we have had once we come out of this coronavirus. Simon Ward, our monetaristic economist, is moving into that camp, but really there’s two very binary outcomes for government bonds here.

So we are less bullish government bonds than we have been, having been huge bulls for 10 years or so. We think investment-grade credit is compelling at these kind of spread levels, and we expect risk assets to wash around with the news flow related to the virus and the economic impact over the coming months. Thank you.

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