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Editor's Note: Hamish Risk | March 16, 2020
In today’s Macro Briefing we focus on the prospects for global markets and the economy in the wake of a tumultuous few weeks contending with the potential fallout from the coronavirus outbreak and a dramatic slide in energy prices. MI2 Partners explains why a potential explosion in US Covid-19 cases combined with signs of fund de-grossing adds up to a perfect storm that may make closing markets a sensible option for now, while Cornerstone Macro warns the lack of clarity over a potential US fiscal stimulus package makes calling the bottom in equity markets well-nigh impossible. Meanwhile, CreditSights stress tests in the US energy sector display worrying signs for the industry, and INTL FC Stone explains why investors in 30-year Treasuries at these level may well suffer a painful fall from grace. Elsewhere, Economic Perspectives dismisses the notion that the world is set for fa deflationary bust, pointing at the inflationary pressures building over the longer term.
fiscal stimulus US economy Cornerstone Macro
1. Hunker down as fiscal stimulus isn’t around the cornerTwo notes from Cornerstone Macro focus on the implications of President Trump’s announcement of halting all travel to with Europe for 30 days. In the first, “Hunker down (March 12)”, the firm says Trump’s speech implies the US government is acting in line with what the rest of US society is doing: hunkering down as it is now clear that significant parts of the economy are likely to practically grind to a halt. Furthermore, says CorMac, it is clear there will be no US fiscal stimulus for now, and while support for such measures may grow, how large it might be, and what form it may take is difficult to judge right now.
In the second, “Fiscal stimulus isn’t around corner (March 12)”, the firm says if a US fiscal boost isn’t imminent, markets have a good deal more downside ahead. The problem for policymakers is that economic data is nowhere near close to matching the markets for speed, so it is not possible to know where to focus government assistance and by how much, says CorMac. Given this, broader fiscal stimulus is the likelier format, but only after a lot more pain will the political will get there, says the firm. CorMac says it’s impossible to model what the “fair value” of the market is given that there is ZERO clarity on how long these issues will last and when and what kind of fiscal stimulus will occur. In the meantime, warns the firm, it very much believes that stocks bottom when there is a catalyst for change (i.e., a solution to the problem is found or started), and that catalyst appears further away than investors had hoped.
An additional third note ”Quick take: The Fed pulls out the liquidity bazooka (March 12)” Roberto Perli provides his quick take on the Fed’s liquidity measures announced today where they announced sweeping measures to address the functioning of the Treasury market, which had been compromised in recent days.
consumer spending Credit Inflation Economic Perspectives
2. This is not the deflationary bust; probability of longer-term inflation resurgence rises materiallyThe latest global inflation report from Global Perspectives notes there is a natural tendency to focus on the consumer and business demand destruction that Covid-19 is wreaking around the world, but this is very far from the whole picture. Indeed, while some will attempt to infer from the collapse in US Treasury bond yields that the world is in the throes of a deflationary bust, says the firm, the reality is different and more complicated, with the probability of resurgent inflation on a 3- year horizon having risen materially. In assessing the global inflation outlook over the next 2-3 years, it is essential to examine the other factors at work, according to Economic Perspectives: first, investors should expect a series of ‘shock and awe’ fiscal responses from G8 countries in mitigation of the disruptive effects of coronavirus; second, investors should not overlook the unfolding profits shock and credit squeeze that could tip substantial numbers of companies into bankruptcy and shatter supply chains and networks; third, warns Economic Perspectives, Covid-19 brings closer the fracture of the entire macro-policy framework on which so many investment strategies rest.
distressed debt high-yield debt US energy CreditSights
3. Oil & Gas – The Night King comethThe crude market has outdone itself, according to CreditSights, with all energy subsectors negatively affected by sliding prices triggered by the oil price war and the ongoing spread of the coronavirus. As a result, the firm has taken a closer look at its IG and HY E&P coverage given the new reality for commodity prices, stress testing credit metrics under $25, $35 and $45/bbl of WTI crude. Using the $35/bbl WTI scenario, 5 of 12 investment grade names under CreditSight’s coverage will have leverage above 3x on a hedged basis and 8 of 12 names are above 4x on an unhedged basis; most of the HY E&Ps would see leverage north of 15x. Nothing will be spared as crude price plummet and energy allocations are cut across the board, says the firm.
bonds hedging sovereign bonds INTL FC Stone
4. Let them eat bondsBuyers of 30-year Treasuries at sub 1% yields will likely suffer a painful fall from grace once history has run its course, warns INTL FC Stone’s Vincent Deluard. To that end, he has issued a report outlining six risks which threaten buyers. According to Deluard, panic buying and one-sided sentiment have made Treasuries extremely vulnerable to a vicious countertrend sell-off, sub 1% yields guarantee real losses over time, and Covid-19 will eventually disrupt supply chains and create inflation. Furthermore, he says the epidemic will likely accentuate bond unfriendly trends, such as de-globalisation and populism, investors that have poured $15 trillion into bond funds since 2007 will need to sell in the next decade, while the dollar might not necessarily retain its safe haven status.
US equities VIX MI2 Partners
5. Covid-19 “perfect storm” and de-grossingMI2 Partners explain why the they believe the US response to the Covid-19 outbreak has been woefully inadequate and why, even allowing for lack of testing, markets will have to brace for a parabolic rise in US cases. Meanwhile, the firm notes the fact that VIX has been above 50 for a whole week, an unusual event that it says will unnerve even the slowest moving of fund managers and has prompted talk of “de-grossing”, when the overall size of portfolios has to be reduced. That process, says MI2, will only accelerate if the correlation between equities and bonds does not normalise and the asset classes cease moving in the same direction, as has been the case in recent days. The firm says investors need to be realistic and realise that as Covid-19 accelerates in the US together, the related economic slowdown, loss of confidence, high levels of corporate debt, and a developing liquidity crunch, are now combining to give investors a “perfect storm”. And just like the movie, it’s hard to see how this will end well, says MI2 – closing the markets maybe a sensible option.