Today, it’s anything but business as usual across global fixed-income markets. Price swings of 20% to 25% in a month are normally thought of as a bad month for stocks, but these days, that sort of price volatility could be used to describe a long bond. Price volatility isn’t the only oddity in the bond market. Consider that in mid-March the Canadian government long bond was yielding 74 basis points.¹ Or consider the case of Austria, which has a 100-year government bond (that’s right, a bond that matures a century from now) yielding just 40 basis points.² If you thought the equity market was volatile, welcome to fixed income!
The antithesis of global growth
Of course, this implausible-sounding volatility is a side effect of the COVID-19 pandemic, which has brought the global economy to a grinding halt. The weight of this imposed economic stasis was simply too much for global fixed-income markets to bear, and so it shouldn’t be surprising that it brought about a quick-onset liquidity crisis.
Near-total stasis in most sectors continues to be destructive to the global economy, which, in the pre-pandemic world, was reliant on the interconnectivity of people and countries to drive GDP growth. Indeed, social distancing and closed borders—the measures required to combat the spread of COVID-19—essentially stand as an inarguable antithesis to the fundamentals of economic growth.
That’s why the recent volatility and the gathering economic damage are so different from what we’d encounter in a “normal” crisis, and why they require a radical government-led response—something that we believe is ultimately likely to go far beyond what developed-market governments implemented in the wake of the 2008/2009 GFC.
Social distancing and closed borders—the measures required to combat the spread of COVID-19—essentially stand as an inarguable antithesis to the fundamentals of economic growth.
Unlimited quantitative easing?
It’s important to review how we got to where we are today, if only to understand why the changes that have happened so quickly aren’t likely to reverse course anytime soon. With the explosion of economic uncertainty in March, traditional correlations broke down. At times, equities were falling quickly, and so were bond prices. Investors couldn’t rely on conventional bond allocations to provide the expected performance buffer.
As it happens, bond market liquidity was facing a multiweek period of unprecedented constraint, especially for short-dated corporate bonds. Specifically, we experienced a dramatic flattening of the credit curve as short-dated paper was used to fund a sudden rush for liquidity and as the market experienced a rapid leverage unwinding. The bond market was unable to trade, and companies were unable to raise required capital. It was in this context that developed-market central banks cut interest rates to near zero, instituted emergency programs to aid market liquidity, and embarked on unprecedented rounds of quantitative easing to support asset prices.
The Bank of Canada (BoC) rolled out more than a dozen different programs in three weeks, including facilities to purchase commercial paper, as well as government and corporate bonds—and this could be just the beginning. The U.S. Federal Reserve (Fed) has also adopted a “whatever it takes” response, surpassing in a matter of weeks some measures that had taken months to establish during the GFC. Fiscal deficits have also ballooned, and commentators have used World War II as a relevant analogy to approximate the financial conditions of our current global situation.³
Government-managed bond market liquidity and credit stability
A critical problem that central banks have tried to tackle head on is how to ensure that a liquidity crisis doesn’t become a full-blown credit crisis—and to do that before the depth of the economic contraction arrives. Lower-rated BBB securities, for example, experienced enormous pressures before government stimulus was passed, with bid-side liquidity severely constrained or nonexistent. Energy producers, pipelines, specialty financials, autos, and real estate all experienced sudden and dramatic weakness. Even large bank paper was under pressure, reflecting the extraordinary demand for liquidity amid the fever pitch of uncertainty.
Given the pressures on liquidity and credit, it comes as no surprise that governments used everything in their toolkits, and even created new tools, to forestall a deepening of the crisis. Potentially unlimited quantitative easing, a sentiment expressed by the Fed, is an unprecedented response from any central bank, but we think it’s the right response if market normalization is to occur anytime soon. And on the fiscal side, it’s perhaps the only option available if governments want to avoid more harmful, long-term destruction of productive capacity.
Conservative positioning, before, and in the midst of, the present crisis
At the beginning of 2020, we were facing a world of low growth, low inflation, and historically low interest rates. The tepid global macroeconomic environment led us to conclude that valuations were virtually the only thing that was high. We were accordingly cautious on risk within our portfolios and calibrated our exposures to navigate a plausible environment in which equity markets corrected in the range of 15%, with a corresponding correction in spread markets.
I’d be the first one to tell you that we don’t try to time the market. It’s not what we do. We are disciplined investors who focus on valuations and fundamentals. We were simply following our investment process when we had de-risked going into the crisis. We thought valuations were rich and, as such, had reduced spread risk in our strategies. So, in essence, we were positioned to weather something like a Category 1 hurricane. But when the storm hit, we suddenly realized we were in a Category 5.
Even now, as we begin to see opportunities emerge in investment-grade corporate credit and elsewhere, we’re still cautious from a fundamental and market dynamics perspective. The fundamental narrative, as we’ve discussed, is defined by weak and uncertain global growth, weak and uncertain earnings growth, potentially significant pressure on corporate balance sheets, and the potential for bankruptcies in certain sectors. Market dynamics are characterized by liquidity strains, as evidenced by ongoing unconventional central bank announcements; selling pressure from exchange-traded fund redemptions; and the potential for further leverage unwind, which could lead to widespread selling across asset classes.
We were positioned to weather something like a Category 1 hurricane. But when the storm hit, we suddenly realized we were in a Category 5.
What we’re watching for in the short and long term
In the short term, we’re paying close attention to the signals offered from short-term money markets. We believe this is one of the best places to read the liquidity signals that have become so relevant across the full spectrum of fixed-income asset types. On a daily basis, we gather information on the strength of short-term liquidity and the operational progress made by the BoC’s purchase programs, which allows us to formulate a picture of how the liquidity landscape is evolving. And while there has undoubtedly been improvement on the liquidity front, there’s still progress to be made in terms of short-end spread tightening and product availability. Changes we see there will affect how we assess risk and deploy capital in virtually every other fixed-income sector in the months ahead.
Taking a longer-term view, we’ll be watching for further changes to fiscal policy. As the financial and economic crisis progresses, we’ll carefully assess whether we have in fact entered a new fiscal policy regime. How will governments think about running deficits in the quarters and years ahead? Because our strategies incorporate government bonds as sources of return, changes in overall issuance will be important to analyze closely. If Ontario, for example, far exceeds its normal levels of issuance, that may imply a substantial change in our spread expectations for that province’s debt. When viewed from a historical perspective, spreads at a certain level may suggest they’re cheap, but if you believe you’re in a new regime for fiscal policy and expect higher average deficits, then you need a new scale for measuring cheapness.
1 Bank of Canada, data as of March 9, 2020. 2 Bloomberg, data as of March 16, 2020. 3 See, for example, “Bad Economic Theory and Practice, Demolished,” prospect.org, April 6, 2020.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material, intended for the exclusive use by the recipients who are allowable to receive this document under the applicable laws and regulations of the relevant jurisdictions, was produced by, and the opinions expressed are those of, Manulife Investment Management as of the date of this publication and are subject to change based on market and other conditions. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers, or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment, or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment, or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer, or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against a loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than 150 years of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams, along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
These materials have not been reviewed by and are not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional.
Australia: Hancock Natural Resource Group Australasia Pty Limited, Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area and United Kingdom: Manulife Investment Management (Europe) Ltd., which is authorized and regulated by the Financial Conduct Authority; Manulife Investment Management (Ireland) Ltd., which is authorized and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad (formerly known as Manulife Asset Management Services Berhad) 200801033087 (834424-U). Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G). South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC, and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates, under license.