Bond Investing in an ongoing Covid-19 crisis
Most of the global bond market sold off sharply in the first quarter as the coronavirus crisis emerged and intensified. Economic activity halted across much of the world. Credit spreads—yields relative to comparable-maturity government bond yields—ballooned to historical wides at a record pace. And even developed-market government bonds suffered from choked liquidity.
As many investors recall from the Great Recession more than a decade ago, indiscriminate selloffs can generate big potential rewards. Today, nearly every fixed-income sector presents such opportunities, albeit in the context of continued volatility over the near term.
But that doesn’t mean our expectations for every sector are uniform. Below, we provide our outlooks for the major bond sectors globally, beginning with an assessment of a condition plaguing all of them: illiquidity.
Policymakers Pull Out All the Stops
Liquidity seized up in March when markets quickly repriced to reflect a significantly darkened economic scenario and uncertainty about how deep and long the coronavirus-induced recession might be. Many sellers came to market, but they found few buyers willing to hold more risk than they already had on their books. Dealer banks that had acted in the past as market makers, stepping in to buy or sell as needed, no longer play the role of buyer in the years since the Global Financial Crisis.
Without this traditional backstop, prices tumbled and the price of liquidity soared. Deleveraging and forced sales worsened the collapse and accelerated the liquidity spiral. As a result, many investors who sold assets in March paid a great deal to do so. Meanwhile, investors also paid a premium to buy the most liquid securities on the market—US Treasury bills. T-bill yields dipped into negative territory in late March as the flight to liquidity accelerated.
In response to the economic shutdown and resulting liquidity challenges, policymakers have rolled out unprecedented fiscal and monetary support globally. Central banks worldwide dusted off nearly every available tool to restore liquidity to markets and support economic growth. The US Federal Reserve cut rates to zero, resumed quantitative easing and launched numerous facilities to ensure that the plumbing of the financial system will work properly again. Other central banks have taken similar actions to support the flow of credit and the normal functioning of markets.
On the fiscal side, action has been swifter and more robust than in 2009. From China to Spain to the US, governments around the world have rolled out massive fiscal aid to keep their economies afloat. While fiscal packages can’t restart the economy before the public health situation eases, they will make it much easier to restart the economy down the road.
It’s early days yet to know whether this flood of stimulus is working. The picture is mixed. On the one hand is an encouraging surge in new issuance. US$100 billion of US investment-grade corporate issues were priced in the market in the last week of March, possibly heralding the return of buyers to the market at these attractive levels.
On the other hand, liquidity remains constrained, albeit mildly improved versus weeks ago. And bid-ask spreads are still very elevated across global bond markets, even for government bonds. On March 31, the bid-ask spread on the 10-year US Treasury was about three times pre-crisis levels.
Most importantly, most countries have not yet seen a peak in COVID-19 cases. Until the pandemic is under control, uncertainty, volatility and trading challenges will persist. Under these conditions, liquidity management remains imperative.
This commentary was written by Scott DiMaggio and Gershon Distenfeld, Co-Heads of Fixed Income at AllianceBernstein.