Largest weekly decline since 2008
Last week, the S&P 500 (SPX) sank by 15.0% — its largest weekly decline since October 2008. In the 22 days since the market reached all-time highs, it has fallen almost 32% [Figure 01]. This type of VaR (Value-at-Risk) shock has never occurred before. Emerging markets (MXEF) and International Developed (MXEA) performed better, down 9.8% and 5.8% respectively.
Markets continue to be incredibly volatile. Monday’s closing CBOE Volatility Index (VIX) level, on the day the S&P 500 fell 12%, was the highest it has ever been. There is cause for hope, however, because on Friday one of the largest option expirations EVER rolled off. And systematic strategies, ones that use volatility to size positions for example, have already dramatically cut positions, so they simply don’t have as much to sell at this point. That means some of the structural forces that have been causing five-plus percent daily swings are no longer with us. So even if the newscycle worsens, the market’s reaction to it may not be as intense as it has been.
Last week, the market seemed to recognize that what’s needed to contain the novel coronavirus will likely have a hugely negative impact on the economy. As of this writing, more than 20% of the U.S. population is in lockdown and, while not in place yet, a national quarantine can’t be ruled out. Absent clarity into what the exact economic impact will be, markets are likely to experience more pain in the short run, requiring truly massive global stimulus to stabilize.
Yields improve, credit spreads blow out
Benchmark U.S. Treasury yields fell last week as liquidity slowly improved, but we’re not out of the woods yet. We need more time to fix the U.S. Treasury market before the Fed moves on to credit. Speaking of credit, spreads blew out again last week, with Investment Grade debt +44 basis points and High Yield +290 [Figure 02]. Though as of this writing, benchmark credit spreads appear to be reacting positively to the Fed’s Monday morning announcement of additional Quantitative Easing (QE).
Fixing fixed income & credit markets
We’ve been flagging how broken fixed income markets are. Last week the Fed acted with overwhelming force to fix them, buying approximately $300 billion in U.S. Treasuries and mortgage-backed securities — almost half of its announced Quantitative Easing in just 5 trading days.
Monday morning, the Fed pledged to make additional purchases without limits and announced the resurrection of facilities from the 2008 Global Financial Crisis playbook, as well as new ones. Among them? A $10 billion backstop to help Commercial Paper liquidity, Primary Dealer Credit lending, expanding dollar swap lines with central banks, and other facilities that further address treasury, mortgage-backed security, commercial paper, municipal bond, and corporate bond markets.
Governments and central banks taking action
The good news here is that governments, central banks, and the private sector are acting. In the U.S., the fiscal package is around $1.3 trillion (and likely to be upsized). Germany is finally spending as well. Globally, central banks cut rates last week, which means that all G7 members are now at or below zero and aggressively engaged in Quantitative Easing. Emerging market central banks are cutting rates too.
Despite this dramatic action, more may be needed. And while we expect normal market function to eventually be restored, it will take some time before that happens.
U.S. dollar moves higher
Finally, the U.S. dollar rose across the board last week. We think this is a key barometer to monitor to be able to assess when the indigestion in asset prices may be coming to an end. In the meantime, upward pressure on the dollar is likely to remain.
What to watch
Response to COVID-19
We continue to monitor both the official government and private sector response to the novel coronavirus in the
U.S. and Europe, including whether there is an increase in testing and screening capabilities.
Health of Fixed Income and Credit Markets
We’ll be keeping an eye on liquidity and funding spreads to see if they react positively to recent Fed action.
Numbers for unemployment claims in the U.S. come out on Thursday. We believe the number will be staggeringly high. A simple model using Google search intensity points to about 650,000 claims, but Goldman Sachs estimates it could be more than 2 million1. Many firms are forecasting the largest drop ever in second quarter GDP.
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