For bond managers, March came in like a lion and went out like a lamb – but there was nothing seasonal about the markets at the end of the first quarter. Three months on from the market shock of early March, when Coronavirus-related panic led to a wave of forced-selling, bringing with it memories of the summer of 2008, for many portfolio managers normality has (for now) returned.
The second week of March will live long in the memory of many a portfolio manager. A shortage of liquidity, caused by a global flight to US$ denominated assets as offshore funds rushed to the ‘safety’ of the dollar, meant that even trades in instruments like core US treasuries were hard to execute as bid-offers widened. In the eye of the storm, the traditional relationship between risk-assets and risk-free ones started to break down: When the Federal Reserve dropped its base rate on 15th March to nearly zero percentage points, the ICE Libor rate rose to 1.58 points above the three month Treasury number. Historically, these two measures track each other at a margin of 15-20bps. Equity markets fell 30% in a week and commonplace debt issues, such as three-month bank commercial paper, shifted from three to nearly ten percent in mid-March. As the dollar squeeze took hold, portfolio managers struggled to meet $-denominated derivative collateral calls. On 9th March the Cable USD/GBP pairing rate traded at 1.31. Ten days later it traded at 1.14, but rebounded to 1.25 within a week or so, meaning that portfolio managers in the Rates category faced highly profitable and loss-making forward positions within relatively small time frames.
One worry was that, in their efforts to reform the banking system since 2008 – and despite an exponential increase in the size of the corporate bond markets since the last crisis – the ability of banks and dealers to hold these assets had tailed off dramatically. There was a sense that a natural brake in the market may have been removed:
"People generally only sell to create the liquidity which they need. The banks don’t make markets in the way they used to, due to balance sheet shrinkage, so central banks and the Fed in particular had to be ready to step in. There’s a belief that central banks are a bit more pragmatic than they used to be".
On 15th March the US Federal Reserve made a series of interventions: A $700bn Quantitative Easing programme was initiated, covering the Treasury and MBS markets. When the market initially responded negatively, a further announcement was made – the QE programme would be “unlimited”. Secondly, a wide range of liquidity measures aimed at supporting the swaps and lending markets was introduced, including commercial paper programmes, a drastic lowering of the cost to banks which sought to utilise its three-month ‘Discount Window’ facilities and - importantly for investors caught in the ‘vortex’ - multiple swap-line arrangements with other central banks, to ensure $ availability. Finally, a variety of purchasing programmes would be available to support the investment grade and high yield bond markets.
A key worry remained – the threat of forced selling in the ETF and passive investing markets, which had grown exponentially since the 2008 crisis. To avoid this, a large ETF and junk bond ETF buy-back programme was initiated. This was so well received that in many cases it wasn’t required - because markets were sufficiently reassured by its mere existence. Flagship IG corporate bond ETF’s at BlackRock and Vanguard rallied by 3-4% within weeks:
‘I look at Credit ETF’s…in March they were trading at a discount to their Net Asset Value – but the system itself didn’t break. Because the banking system itself wasn’t impaired, investors rightly assumed that things would get better and some sizeable packaged ETF trades were completed.’
Other central banks launched their own QE programmes and introduced funding for IG stalwarts like RyanAir, which had the effect of opening a broad body of new issuance by companies which operated in sectors most exposed to Coronovirus-induced business interruption. Knowing that the market would be supported in its efforts to recapitalise afflicted (but otherwise strong) names, investors formed an orderly queue. Many companies in the travel sector, including the aviation industry were able to draw on revolving credit facilities whilst they bought time for recapitalization. They were happy to issue at more than 5%, safe in the knowledge that, once financial flexibility had been achieved, investors would re-evaluate sensibly. Cruise company Carnival succeeded in a $multi-billion secured issuance programme because its pre-crisis debt had been in the unsecured category. Irregular issuers like 3i issued long term debt successfully, whilst Morgan Stanley, Coca Cola and Intel all issued 30-year bonds during this time.
Cash which had been held on the sidelines proved sufficient to absorb the growing pipeline of issuance and, as we go into the summer months, bond managers are once again hunting for new sources of credit. Niche credit markets demonstrated a hitherto-unproven flexibility as they successfully flipped their investors bases: The EETC aircraft leasing securitisation market appealed to a series of distressed debt investment funds, which were happy to take the increased risk-and-reward available, in a market which remains short on longer term capacity.
Closed-end funds were winners, because many open-ended debt funds and ETF’s were (temporarily at least) caught in the wave of forced redemptions - either through fear, or because they faced potential liquidity or capital problems of their own. Many were unable to take advantage of the opportunities offered in April and May. Life insurance companies (provided they could avoid the downgrades) and defined benefit pension schemes stood to gain a premium from using the duration on their balance sheets to hold their positions, or add to them:
"In these scenarios, there’s a common belief that lots of sellers come into the market, anxious to monetise their assets at any price. People overestimate this. For insurers, the concern was Ratings Migration, but that’s not a decision you are going to make on the 18th of March. You will wait until you have a longer term sense of the trends and the impacts on individual names."
But there’s a concern that the success of the debt markets in absorbing the immediate financial impact of the crisis on large corporates might be masking the scale of the problem ahead:
"I feel that the market is now out of place with the fundamentals of the economy. The market is pricing-in a full recovery in areas like the travel and car industries. There’s no way that these markets will return immediately to good health. Central bank balance sheets are ballooning and there will be risks. In the long term, we don’t know how this will end…"
With thanks to Azim Meghji, Tim Li and David Ric…
In Europe, investment grade-rated companies raised $83.2 billion in April, according to Refinitiv data, beating the last biggest month in 2009 as central banks stepped in to unblock credit markets frozen by panic over the coronavirus. The flurry of European activity lifted global investment grade issuance to a record $350 billion - the second consecutive record month for top-rated corporate debt, which excludes bank-issued bonds. In the U.S. market, firms in April raised $162.7 billion, beaten only by March’s record, Refinitiv data shows. “We’ve been off the charts busy,” said Frazer Ross, head of EMEA debt capital markets syndicate at Deutsche Bank. “Maybe the issuers need the liquidity or maybe they don’t but they are showing the market they can get it,”