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How steep is your swoosh?

By Henry Adams on 2020-06-25

Never a dull market, despite these geographically constrained times.

As the mind wanders to holidays remote and luxurious, the reality of much of the world still being shut brings me back to completing our latest commentary. It is rather concerning to see the rise in new outbreaks and the pace at which they are brought back under control, as well as how challenging it is (and understandably so) for some nations to get over the first (and hopefully only) peak. Looking at the stock market, one might well think that a vaccine had been found and distribution was around the corner. Had I been in a coma since January and awoken to see the NASDAQ up almost 12% I might be forgiven for thinking Corona was just a popular summertime drink I might look to reach for, ensuring lime was in place prior to purchase...

It appears almost certain now that the shape of the recovery will be a "swoosh" at best (unless interfering with the X-axis, which seems to be the modus operandi for some). Yesterday the IMF revised (downward) the growth trajectory for the global economy from -3% to -4.9%, with advanced economies set to take the brunt of the hit, estimated to be -8% for 2020 along with global debt-to-GDP exceeding the less than magical 100% for the first time. The outcome of a UK report published by LM Research & Marketing Consultancy on Wednesday surveying 2,000 companies with employees of between 1-249 people demonstrates the potential pain to come, with 25% of those surveyed planning to cut staff numbers following the discontinuation of support for furloughed workers. In the US, a similar report highlighted that “at least” (read more than) 1 in 10 workers would face a similar fate there. With US home-mortgage delinquencies already rising to the highest levels in 9 years and increasing reports of similar dynamics in the commercial mortgage market, several records look set to sadly be broken.

Last week the term financing operations for banks from the ECB were popular, to say the least. EUR 1.3Tn was pushed out the door at -1.00%. That’s right. Banks are being paid 1% per annum on the money they borrow from the Central Bank. The idea is that the margin compression they have been suffering is partially alleviated by the “cheapness” of this new money they receive for the purposes of arbitraging government bond markets lending to the real economy. Two examples of the impact of this measure at both ends of the maturity spectrum highlight this neatly. Italian Government bills with a 12 month maturity have moved almost 30 basis points (more expensive...) with no new meaningful country specific measures executed, nor indeed a change in base rate. At the other end of the spectrum, way out beyond the horizon, Austria has successfully issued a bond with a maturity of 100 years at 0.88%. Less than 1% return per year, for 100 years. I think it is safe to say that I am unlikely to see redemption proceeds, whether Austria is able to meet its obligations or not! Closer to home, we continue to find new opportunities with an increasing number of EUR products to help reduces our clients drag on cash in a manner that does not increase exposures, and indeed actually reduce counterparty risk.

Governor Bailey of the Bank of England has declared that the Bank's balance sheet will be shrunk (or at least reduced to pre-pandemic times) prior to any rise in interest rates. GBP markets took this to be a sign that rates will be lower for longer than previously expected, in particular given this policy is the opposite of his predecessor, Mr Carney. Government bond yields remain negative in the 2 to 5 year space, despite partially selling off from the decreased pace of quantitative easing purchases to the end of the year. The UK Treasury Bill auction will prove to be potentially painful for those participating this week, with yields grinding ever-closer to zero week on week and a reduction in supply this week from £5.5Bn to just £1.5Bn in a market that was already well-bid and oversubscribed. Could this be the week that we break into negative yields, given we have an almost perfect storm of quarter-end and thus shortage of bank balance sheet across the city? If there is only one price, it is the best price.

In the US, with the changes around Federal Reserve operations in the repo market and subsequent price increases, a return to US Treasury Bills with a consistently double-digit yield is no longer a pipe dream. Central bank swap lines are being reduced, interestingly just after quarter-end (it would take real confidence, or stupidity, to do so prior) indicating that the liquidity crisis and shortness of USD has somewhat abated, for now at least.

In other news, it was both interesting and somewhat worrying to see Fidelity, one of the largest asset managers in the world, closing another two money market funds (assets of $14Bn) taking the total to 5 (or, in monetary terms, $85Bn) closures since the beginning of March. Reasons for doing so have been cited as avoiding “headline risk” of losses on portfolios should investors look to switch out of funds again in a product that should always be returning full principal. According to Fidelity themselves, institutional Prime Money Market Funds are a “magnet for volatility”.

Indeed, recent events have again brought the structural instabilities of maturity-transformed funds into stark focus (reference below) and it seems that Central Banks may finally have grown tired of picking up the tab for a fund management industry that promises clients abundant liquidity when the queue at the bar is short but relies on a money-printing sugar-daddy to pay the bills whenever everybody wants a drink. The spectre of "privatised profits and socialised losses" from Wall Street left a very sour taste for many on Main Street in the aftermath of 2008 and the Bank of England, amongst others, seems keen to avoid similar future criticism, with Governor Bailey stating: “Rather than having to keep relying on central bank support for all aspects of the financial system, we need a robust assessment of the latter’s weaknesses...The role of money market funds, and the risks to financial markets that they posed at the height of the disorder, is one area to examine.”

Avoiding the risks of maturity transformation, fixed income illiquidity and default correlation were the guiding principles for the design of our Fixed-Term Fund platform. By operating on a maturity-matched basis and diversifying away from pure unsecured bank risk, we are delivering a set of products that is safer for our clients, as well as for the financial system as a whole. If you would like more information, you know where to find us!

Articles of interest:

Fidelity Investments intends to 'hard close' two institutional money market funds to curb exposure to COVID-19's high-volatility market

The Looming Bank Collapse

References

U.K. Firms Plan to Cut 25% of Furloughed Workers in September

BLACK KNIGHT’S FIRST LOOK AT MAY 2020 MORTGAGE DATA

A Crisis Like No Other, An Uncertain Recovery

An FTF or Fixed-Term Fund is a regulated fund investment that offers exposure to a single investment-grade obligor for a fixed term, without the need for any client infrastructure. An FTF has many of the same characteristics as a term deposit, but can offer exposures outside of the banking sector. TreasurySpring is originating FTFs with sovereign, financial and corporate obligors.


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