By Henry Adams on 2020-10-01
With so much going on at home and across developed economies it is challenging to keep up with other important events unfolding that are both meaningful and worth keeping abreast of.
Western financial press has been focussed on the size and nature of stimulus packages supporting everything from jobs to house prices to entertainment venues and the arts. Further afield, in those countries with less of a safety net, we do find ourselves witnessing greater diversion and rising risks that have the potential to trigger broader global consequences. Since the end of March, Fitch alone has made 36 Sovereign downgrades across 31 different countries* - this is particularly notable when compared with the previous record year of 24 Sovereign downgrades in 2016, without even considering those additional countries on negative watch (where the US now finds itself) in a year that still has a quarter to run.
There is real risk of contagion especially where geographies and/or trading routes are intertwined and ability to repay sadly continues to deteriorate. Defaults from one are likely to impair the ability of another to repay, and so on…When the risk-free rate is no longer risk free and benchmarks widen out off the back of record debt issuance and artificially low rates across the board, an outgoing tide could be painful, hazardous and infectious.
Right now, inflation, that mythical 2% target, could very well become our friend. We have heard from the major central banks of the world that adjustments are being made to include additional indicators, essentially allowing it to overshoot (for example in the US targeting inflation AND full employment prior to raising rates). Lagarde of the ECB stated literally yesterday that exceeding 2% for a period might be favourable. Inflating the debt away certainly beats trying to pay it all back.
In Euroland a further TLTRO III (targeted longer-term refinancing operations) proved popular last week, coming in at the thick end of expectations. EUR 174.5Bn was lent to 388 banks for 3 years at -1.00% (yes, getting paid 1% by the ECB to borrow…!) , pushing excess liquidity in the system to an estimated EUR 3Tn. Let’s hope it really does make it into the real economy rather than arbitrage profits on bank balance sheets. The graph below highlights what these gargantuan injections of exceedingly cheap money have done to term bank borrowing rates (using 1,3,6 & 12m Euribor). Given these dynamics, it is no surprise that the team here has witnessed the rug being pulled from under EUR depositor's feet, with even the most important bank clients pushed into negative deposit rates over the last couple of quarters, with the average now around the ECB Base rate of -0.50% (assuming you are not a financial institution, in which case achieving even base rate might be something of a pipe-dream).
It is worth highlighting that in recent weeks, we have launched several EUR FTFs (offering exposure to highly-rated issuers) that enable clients to reduce the drag of negative rates considerably. We can even offer a flat zero EUR return if funds can be termed out for just three short months.
It has been a bumpy ride for GBP of late, with the Bank of England highlighting an unholy trinity of potential large downside scenarios playing out, being a second wave, high and stagnant unemployment and Brexit (or more specifically, no deal). Back-peddling on negative rate chat has been the theme from Threadneedle Street, although were all three risks to materialise then there may well be no other choice to further stimulate the economy and lower the price of servicing already ballooning debt (UK Government Debt has increased 18.9% as a proportion of GDP in the last 6 months alone, a pace last seen during WW2).
Just yesterday morning, UK GDP figures were published with the QoQ results coming in at -19.8% and -21.5% YoY. Private and public spending was also down by 23.6% and 14.6% respectively - a bounce in either or both of these would be very helpful at this stage, although not obvious given the imminent end to the furlough scheme and the advent of a Winter Economy Plan that targets only areas of the economy deemed to be sustainable in the longer term and requires rising financial commitment from employers. That and the curbing of social functions and restrictions on travel make it harder to spend, even if you wanted to.
Last week represented another record for the UK Government Bill market, and not a good one for buyers! All three maturities (1, 3 and 6 month) saw average yields print in negative territory for the first time ever. There are still great opportunities out there to enhance yield without risking shirts off backs in the GBP cash investment space, however - more from us in the coming weeks on that...
Electioneering, an inability to agree on the size and shape of a further stimulus package, coupled with record low LIBOR rates have made the Greenback (or USD) a tricky space to find yield or equally a fair risk-adjusted return. With US Treasury Bills stuck in the single digits out to 6 months (and beyond) and LIBOR spreads at unfathomably tight levels, Government Money Market Fund yields something that looks more like a rounding error than a return. Whilst Prime rates are still sat above the Government benchmark,spreads are thin. For a structurally insecure and about to be reformed product, many are rightly questioning the validity of taking on the additional liquidity risk to net half a dozen basis points.
You can of course risk less and earn more by investing in Fixed-Term Funds...
*(in order of timing) Ecuador (three times and now in default), the Maldives, Columbia, Gambon, South Africa, Guatemala, Nigeria, Argentina (into default but now technically back out, "restructuring"), Aruba, San Marino, Mexico, Zambia (three times, now just above default) Cabo Verde, Hong Kong, Sri Lanka, Italy, Seychelles, The UK, Slovakia, Tunisia, Costa Rica, Laos (twice), Peru, Namibia, Canada, Suriname, Oman, Bahrain, and Angola.
Articles of interest
Money market turmoil in March shows past reforms may be insufficient-U.S. Treasury official
Asset managers overhaul money market funds after March rout
Shapes of Recovery: When Will the Global Economy Bounce Back?
Bank of England reaches target for corporate bond purchases
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.