Are we in the midst of a full-blown liquidity crunch?
Markets are moving at lightning speed in response to the clear and present danger of the halting of economies and changing consumer behaviours.
Last weekend Putin flew a metaphorical 747 into the heart of the US energy industry when it is already shockingly vulnerable, crushing oil prices and blowing high yield credit spreads sky high, forcing a recalibration of all spreads globally. There will be exceptional opportunity in this over time, but for now we are in the midst of a full-blown liquidity crunch, driven by the unknown tenor of this ongoing cashflow crisis.
We think that the Federal Open Market Committee (FOMC) will cut 100 basis points next week, and launch additional ‘whatever it takes’ measures. Markets should be closed to allow for improvement in virus news flow, which we have now seen in China and South Korea.
Our major concerns remain that we have weak global leadership in this moment. Trump, has resisted expert opinion and recently publicly dismissed the virus as ‘’a bad flu’’, letting the virus run wild in the United States. Markets are correct to price material unknowns at this time. The European Central Bank’s (ECB) chief Christine Lagarde seemingly undid the ‘’whatever it takes’’ mantra in yesterday’s ECB press conference. She stated that in order to turn this, a plateau in virus news flow is needed (hopefully warmer weather and significant improvements in public health awareness will provide this in time), or an enormous coordinated rescue package.
Dislocation in markets as forced selling and deleveraging take over
We are seeing huge dislocations in markets where forced selling combined with deleveraging is causing all manner of chaos. Central bankers are trying to solve a crisis of their own making using more liquidity poison. Having removed much of the stock of liquid risk free assets with multiple Quantitative Easings and liquidity programs over the last 10 years, they have forced investment communities into lower and lower quality, or illiquid positions, to generate income and yield. Once the cascade of these positions starts to outflow en masse, the system seemingly buckles under its own weight. The market demands a rescue package of untold proportions to suppress this volatility, or the markets will continue in a self-fulfilling spiral in the near term.
This is a supply side shock, and as we’ve previously written, that is far more complicated this time than the usual channels of creating demand. We would caution that this can last a long time. Rescue packages did little to halt the GFC declines, as counter trend rallies were met with powerful selling by trapped longs. In the GFC, equity markets took 17 months from peak to trough. So far everything has happened much faster in an increasingly electronic and algorithmic environment; when we might find a floor is anyone’s guess. Governments are trying to flatten the spread of the virus, market regulators need to flatten the speed of this decay.
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Charles is a co-founder of Jamieson Coote Bonds (JCB) and oversees portfolio management of the Australian and Global High Grade Bond and Dynamic Alpha investment strategies. Prior to JCB, Charles forged a career as a seasoned bond investor from...