Assessing the market impact of the coronavirus outbreak from a fixed-income perspective

Financial markets slumped this week as the spread of the coronavirus to Europe and the United States prompted fears that the economic impact of the outbreak could be much larger than thought.

Market assessment

Over the past one to two weeks, we’ve seen concerns regarding the coronavirus outbreak transform from a perceived local China problem to more of a global shock as the virus has spread regionally in Asia, in addition to countries within Europe, the Middle East, and even Latin America.

U.S. markets—having been resilient to the initial sell-off in Asia—were awakened over the past few days to the potential impact on global growth of a broader disruption in economic activity that looks increasingly likely.

Risk assets took another blow after the Centers for Disease Control and Prevention (CDC) press conference, where officials noted that “it is not a matter of if, but a question of when”1 the virus is spread in the United States, while stating that a global pandemic is likely. The director of the CDC later assured, however, that steps the United States has taken to contain the virus have worked, and that the country is well prepared to deal with an outbreak.

The fallout has sent U.S. Treasury yields back to record lows and the market is now pricing in ~2.5 rate cuts from the U.S. Federal Reserve (Fed) over the next year.2 For its part, the Fed has yet to pivot from its neutral stance with comments generally keeping its cautiously optimistic tone as it relates to the U.S. economy while stating that current policy remains appropriate, and that it expects the coronavirus impact to be temporary in nature.3

In the corporate high-yield universe, we’ve seen orderly selling, which has caused spreads to widen by about 75 basis points (driven by weakness in the lowest credit qualities, in particular, CCC-rated debt). However, the total drawdown has been muted by the move lower in U.S. Treasury yields.1 From a currency perspective, the U.S. dollar has broadly benefited in February on a mix of safe-haven demand and relative outperformance in economic growth expectations. 

Our view

We’re cognizant of the fact that global growth expectations are likely to be revised lower in light of the prolonged duration of the outbreak, and recognize that the probability of a global recession has risen in recent weeks. Our base case scenario continues to be one of a temporary disruption to economic growth, barring a material escalation in the spread of the virus in the United States and Europe.

As the situation remains fluid, we believe it’s prudent to remain cautious in the near term and continue to maintain a relatively defensive stance from an interest-rate, credit, and currency perspective. We’re currently looking for broad-based dislocations to identify targeted situations that we can take advantage of on a tactical basis, particularly in countries and sectors that are less reliant on global demand forces. That said, patience and selectivity will be key.

At this juncture, we also believe that a slightly longer duration—at least in the coming weeks—makes sense if the situation deteriorates further (i.e., significant spread across the United States). 

 

1 “CDC official warns Americans it's not a question of if coronavirus will spread, but when,” CNN.com, February 26, 2020. 2 Bloomberg, as of February 27, 2020. 3 “Fed’s Clarida says ‘still too soon to even speculate about impact of coronavirus,” marketwatch.com, February 25, 2020.

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Daniel S. Janis III

Daniel S. Janis III, 

Senior Portfolio Manager, Head of Global Multi-Sector Fixed Income

Manulife Investment Management

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