Uncertainty surrounding the magnitude and duration of the global health crisis is driving volatility and testing liquidity across the world’s financial markets. In addition to the supply chain disruption and demand destruction resulting from the coronavirus, an additional, and also severe, supply shock has been introduced to the US and global economy. Saudi-led OPEC has embarked on an oil price war with large non-OPEC oil producers, putting investors on high alert for a global recession, and raising the odds of a US recession. Central Banks in action: On Sunday, March 15, coordinated action among G-10 central banks, plus the Federal Reserve’s dramatic announcement of zero-bound interest rates and quantitative easing, aimed to stabilize market liquidity and confidence. The Fed also reduced bank reserve requirements to zero, thereby freeing up liquidity for every bank in the country. This allows banks to make more loans, and improves their margins as cash moves from the Fed’s near zero rate on bank reserves to higher yielding assets. This comes after the Fed’s meaningful commitment on Friday to infuse $1.5 trillion into short-term funding markets. Last night measures were not able to calm financial markets. Equities are posting significant losses in Europe, volatility is reaching the record levels touched during the Great Financial Crisis and US Treasury yield is trending lower. These measures aim at restoring liquidity in the system, easing financial stress and avoiding that the productive part of the economy suffers from permanent disruption. However, these measures can do little to support the demand side or restore supply chains: over reaction and volatility are here to stay, until we see the containment measures producing some effects, fiscal stimulus becoming more prominent and coordinated (we expect measures from today Ecofin) and prospects of medical treatment. Markets are also looking at what happened in China. Recent data released showed that the industrial production, retail sales and capital expenditures tumbled in the first two months of the year. Now the activity is resuming but the damage has been high and this is what markets expect for the rest of the world now dealing with Covid-19. So little comfort for markets, until some more concrete signs of recovery materialize in China, to show the possible path ahead. Fiscal policy is now “on the clock.” All eyes are on Washington and on the potential for easier fiscal policy beyond what has already been approved by the House of Representatives. Follow-through from the US Executive branch and Congress – and government bodies around the world - with fiscal stimulus will be critical to sustain and accelerate the central banking system’s leadership. We are encouraged by the powerful infusion of liquidity and apparent solidarity of the central banking system. As we see the market and fiscal response play out, we will continue - with purpose and patience - to keep a strong focus on liquidity and high flexibility. Active long-term investors should continue to carefully identify mispriced securities and reposition portfolios to ensure ample liquidity as well as to take advantage of the dislocation in asset prices for the benefit of long-term investment returns.
