By recent standards, equity markets had a quiet week last week. Emerging markets outperformed, down only 1.2% (MXEF), while International Development markets lagged, finishing down 3.7% (MXEA). Domestic equities landed somewhere in-between at -2.0% (SPX). Month and quarter end are now behind us and with them, the much-discussed pension rebalance into equity markets. There was some equity demand last Monday and Tuesday, before fading for the rest of the week.
Under the hood domestically, it’s a growth and large-cap led market. An outlier was the energy sector, last week’s best performer. Reports that Saudi Arabia and Russia might reach a deal to cut production, potentially with curbs from the U.S. shale industry as well, drove crude oil sharply higher. It closed up almost 28% last week (CL1), but remains down over 50% year to date.
Volatility declines — bottom near?
Both implied and realized volatility are falling, an encouraging sign. The CBOE Volatility Index (VIX) was down approximately 29% last week, and 10-day realized volatility is at 72, down from its peak in the mid-120s just a week and a half ago. While volatility is still much higher than average, the fact that it’s trending downward is consistent with markets potentially finding a bottom.
Bond volatility is also down 60% (MOVE Index) from its peak in the second week of March. By comparison, the VIX is down only 43% from its peak, which came a week later. This strongly supports our view that controlling bond markets is key to restoring proper functioning to the equities.
Fixed income market healing, not healed
It’s Groundhog Day (the movie) in government bond markets. Interest rates declined again as market function continues to normalize. This normalization comes as the Fed cut its purchases last week, and plans to buy even fewer bonds this week. Despite this, yields keep falling. The 2-year is now under the federal funds upper target band and the 10-year fell 8 bps last week to 0.60%. It’s quite stunning to contemplate, but the market essentially doesn’t expect the Fed to raise rates for at least four to five years.
What broke the bond market?
We may also have indication now of what caused the U.S. Treasury market to break in the first place. According to New York Federal Reserve custody data, foreign central banks sold $113 billion in U.S. treasuries (UST) in March. Per UBS calculations, if you scale that up to include UST not custodied at the Fed, central banks sold approximately $250 billion worth last month, presumably to raise cash to support their economies.
Credit stabilizing, still stressed
In the credit space, markets reversed some of last week’s improvement. Institutional Grade (IG) credit spreads ended 16 bps wider, while High Yield (HY) ended 151 bps wider, a particularly poor showing with the rebound in crude oil. A HY issuance did come to market, however, and IG issuance is extremely strong. Because the Fed’s purchase program is not yet up and running, it should take time and economic clarity to see significant credit spread tightening.
Finally, the quarter-end brought some normalization to funding markets, but the U.S. dollar (USD) remains firm, up 2.3% last week. Until we get real clarity on the global economic restart, this trend is likely to continue.
Newscycle paints grim picture
The newscycle continues to paint a grim picture with respect to COVID-19. Most models point to a peak in new cases within the U.S. sometime this week, but with limited testing and shaky data, uncertainty around these estimates is high. The White House pointed to a potential for 100,000 to 240,000 deaths in the U.S.
Meanwhile, the economic impact of social distancing and other virus mitigation measures came into sharper focus last week, with 6.6 million new jobless claims filed for the week ended March 28th. In just two weeks, 10 million people lost their jobs in the U.S.
Loans to small businesses started on Friday, though it appears there were some issues with the rollout. Markets will focus on the effectiveness of this program, as well as what may be included in the Phase Four stimulus bill. Unfortunately, that legislation is still weeks and maybe months away. When it does come it’s likely only to cushion the downturn, helping to avoid a depression, rather than spur any kind of rebound.
What to watch
Coronavirus – As we said on Friday, the U.S. economy’s future at this point will be largely influenced by what the virus does and for how long, and what the public health response is to it. While many different treatments and vaccines are being talked about and pursued, the situation is too fluid and we believe it premature to suggest that there is a treatment or definitive end to this health crisis in sight. But there is potential for a peak in new U.S. cases within the next two weeks, as appears to be happening now in Europe. We’ll also be watching to see if hospitals and health systems are able to add additional capacity for testing and treating COVID-19 cases.
Jobless claims – The key economic report this week will once again be jobless claims. The whisper number is another 5 million claims. If we see several weeks in a row of these levels of claims, some economists think the unemployment rate could reach as high as 15% by the end of April or May.1
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