It was as if global markets pulled elements from the 1994 bond market dislocation, 1997’s Asian Bubble collapses, the 1998 Russian/LTCM fiasco, and the 2008 market crash – and synthesized them for a week of ridiculous market instability and dysfunction.
Thursday was an extraordinary day of global market panic – The “Worst Day Since the 1987 Market Crash” – “Biggest VaR Shock In History.” Add the “worst week for Credit in Decade.” It was the dreadful global de-risking/deleveraging episode – a disturbing case of synchronized liquidation, market illiquidity and dislocation. Global markets – stocks, bonds, Credit, derivatives, currencies and commodities – were all convulsing and “seizing up.”
The Dow sank 2,353 points, or 10.0% Thursday, with the S&P500 sinking 9.50%. Italy’s MIB index collapsed 16.9%, Germany’s DAX 12.2%, Spain’s IBEX 14.1%, and France’s CAC40 12.3%. Major equities indices were down 14.8% in Brazil, 12.7% in Poland, 11.5% in Hungary, 8.3% in Russia, 8.2% in India and 10.8% in Thailand. Japan’s Nikkei traded down as much as 10% in early-Friday trading before ending the session with a 6.1% loss.
Equities markets almost appeared orderly compared to Credit market mayhem. An index of U.S. high-yield CDS surged 92 bps to 685 bps, capping off a six-session surge of 317 bps to the highest level since the crisis. For comparison, this index spiked 138 bps in seven weeks to 485 bps during the late-2018 dislocation. An index of investment-grade CDS jumped 21 bps Thursday to 139 bps, with a six-session surge of 73 bps to the highest level since 2011.
March 12 – Bloomberg (Katherine Greifeld): “Bond ETFs are highlighting signs of liquidity stress in broader markets, with cash prices trading at persistent and deep discounts to the value of the underlying assets. The $31 billion iShares iBoxx $ Investment Grade Corporate Bond ETF closed at a discount of 3.3% to its net asset value on March 11, the largest such divergence since 2008… Meanwhile, the $23 billion iShares 20+ Year Treasury Bond fund’s price has dropped 5% below its net-asset value, the most ever. And even the U.S. municipal market is feeling the squeeze: The VanEck Vectors High Yield Municipal Index ETF traded at a record 8.3% discount on Wednesday.”
March 12 – Bloomberg (Alexandra Harris): “Libor-OIS expands to 61.1bp, the widest level since May 2009, from 52.6bp the prior session as funding pressures in the credit market continue to build.”
The iShares High yield ETF (HYG) sank 4.0% Thursday and 5.9% for the week. After ending last week at an all-time high, the iShares Investment-grade ETF (LQD) dropped 4.8% Thursday and 8.4% during the week. There were issues as well in mortgage-backed securities and municipal debt markets. After closing the previous Friday at a record low yield, benchmark MBS yields surged an eye-popping 48 bps to 2.37%. A couple Bloomberg headlines: “A Day of Hell: The Muni Market’s Worst Day in Modern History,” and “For the Muni-Bond Market, It’s the Worst Week Since 1987.” Across the derivatives markets, it was utter mayhem.
Emerging market (EM) bonds were ravaged. Yields on Brazil’s local currency 10-year bonds surged 125 bps to 8.29% in Thursday trading. Yields jumped 98 bps in Hungary (to 2.97%), 76 bps in Russia (7.98), 71 bps in Colombia (7.65%), 55 bps in South Africa (9.81%), 44 bps in Mexico (7.72%) and 39 bps in Romania (4.52%).
For the week, local currency 10-year yields surged 292 bps in Ukraine, 127 bps in Mexico, 113 bps in Brazil, 107 bps in Turkey, 95 bps in Philippines, 92 bps in Russia, 88 bps in Chile, and 84 bps in Indonesia. “Carry trades” blowing up.
EM dollar-denominated bonds were not spared the bludgeoning. Thursday’s upheaval saw yields spike 172 bps in Ukraine (to 11.09%), 76 bps in Brazil (4.36%), 67 bps in Turkey (7.26%), 62 bps in Russia (3.66%), 61 bps in Mexico (4.12%), 45 bps in Philippines (2.76%), 38 bps in Indonesia (2.88%), and 36 bps in Chile (2.64%). For the week, yields surged 284 bps in Ukraine, 120 bps in Mexico, 107 bps in Brazil, 107 bps in Turkey, 87 bps in Russia, 86 bps in Chile, 82 bps in Philippines, and 74 bps in Indonesia.
In EM currencies, the Russian ruble fell 2.6% Thursday, the Colombian peso 2.6%, Mexican peso 2.5%, Czech koruna 2.3%, Chilean peso 2.1%, South African rand 2.1%, Polish zloty 2.0% and Turkish lira 1.7%.
Curiously, Thursday’s bigger moves were in “developed” currencies. The Norwegian krone sank 4.7%, the Australian dollar 3.8%, the New Zealand dollar 2.9%, the Swedish krona 2.4%, the British pound 1.9% and the Canadian dollar 1.1%. For the week, the Mexican peso dropped 8.3%, the Norwegian krone 8.1%, the Australian dollar 6.5%, the British pound 5.9%, the Brazilian real 4.3%, the South African rand 3.7%, the New Zealand dollar 3.4%, the Swedish krona 3.2% and the Canadian dollar 2.8%.
It’s fair to say that trading was in particular disarray wherever the levered funds have been active. Especially Thursday, markets traded as if cluster bombs besieged the leveraged speculating community.
Italian government yields surged 58 bps Thursday to 1.76%. With German bund yields little changed on the day, the Italian to German yield spread widened a remarkable 58 bps in one session. Greek yields jumped 50 bps (to 2.04%), with Portuguese yields up 32 bps (to 0.72%) and Spanish yields rising 25 bps (to 0.51%). For the week, Italian yields spiked 71 bps and Greek yields surged 70 bps. Yields were up 52 bps in Portugal and 41 bps in Spain. Ominously, safe haven German bund yields jumped 17 bps despite all the mayhem.
March 9 – Bloomberg (John Ainger and Anooja Debnath): “Fund managers are being faced with a collapse of liquidity as they try to handle record market moves. Investors say it is becoming increasingly difficult to trade due to the extent of swings on a day that saw 30-year Treasury yields drop the most since the 1980s and a fall in U.S. stocks so sharp that trading was halted minutes from the open. Even before today financial conditions were tightening at the fastest pace since the 2008 crisis. ‘I have yet to find liquidity,’ said Richard Hodges, a money manager at Nomura Asset Management, whose bets on Italian and Portuguese bonds last year put him in the top 1% of money managers. ‘There is none.’”
March 12 – Financial Times (Joe Rennison and Colby Smith): “Investors and analysts are warning about deepening cracks in the world’s largest government bond market. Strange patterns have started to emerge, such as drops in the price of US Treasuries — a traditional haven — even while riskier assets such as stocks have been squeezed by fears that the coronavirus outbreak will spark a global recession. Some are warning that the patterns could lead to the unwinding of one of the market’s most popular trading strategies — with potentially serious consequences.”
As global markets “seized up,” safe haven Treasury bonds were notable for providing minimal offsetting benefit. There was actually a point late in Thursday’s session where yields were higher on the day (before ending the session down 6bps to 0.81%). For the week, 10-year Treasury yields surged 20 bps – changing the calculus of Treasuries as a hedge against the risk markets and systemic risk more generally. Seeing the Treasury market succumb to illiquidity and dislocation could have been the most troubling aspect of a deeply troubling week.
The Federal Reserve was a busy bee. Last week’s emergency 50 bps fell flat in the marketplace. The New York Fed on Monday raised the size of its overnight repo liquidity operations 50% to $150 billion. It also more than doubled the size of the two-week repo facility to $45 billion. These measures were “intended to ensure that the supply of reserves remains ample and to mitigate the risk of money market pressures that could adversely affect policy implementation.” Whatever the intention, they suffered the same fate as the emergency cut. The Fed was back Tuesday to boost overnight operations to $175 billion, while adding a $50 billion one-month “term repo.” Still no pulse.
Thursday’s “seizing up” brought out the “whatever it takes,” “insurance”, shock and awe bazookas. It was surreal listening to analysts on Bloomberg and CNBC trying to comprehend exactly what the Fed had announced. I appreciated the Financial Times (Colby Smith and Brendan Greeley) effort: “The Fed would now offer up at least $500bn in three-month loans, beginning immediately, with another $500bn of three-month loans on Friday. It said it would also provide a $500bn one-month loan on Friday that settles on the same day. It also said it would continue to offer $500bn of three-month loans and $500bn one-month loans on a weekly basis until April 13, on top of its ongoing programme of $175bn in overnight loans and $45bn in two-week loans twice per week.” Holy Crap: Desperation.
The Dow surged almost 1,500 points in a matter of minutes. Hopes that prospects for Trillions of Fed liquidity had finally reversed the markets were quickly dashed as prices reversed lower to end a day of panic at session lows.
Japan’s Nikkei traded down 10% in early-Friday trading, as overnight S&P500 futures dropped another 3%. On prospects for aggressive global fiscal and monetary stimulus, Japanese and Asian stocks cut their losses. European stocks rallied sharply, with major indices up near double-digits by the time U.S. exchanges began trading. The S&P500 opened 6% higher, though most of the gain had disappeared after a couple hours. No rest for the weary. The Fed had yet another announcement, stating it would be purchasing longer-term Treasuries (instead of T-bills) in its monthly QE purchases (acquiring $37 billion by the end of the day). The President scheduled a coronavirus press conference during the final hour of the market session. The Dow rallied 1,500 points in the final 34 minutes of trading, as “Stocks Retrace 90% of Thursday’s Epic Plunge with Late-Day Surge.” Well-orchestrated.
March 13 – Financial Times (James Politi, Lauren Fedor and Courtney Weaver): “Steven Mnuchin, the Treasury secretary, said US authorities will do ‘whatever we need to do’ to boost liquidity in financial markets and help the US economy weather the coronavirus outbreak, including action by the Federal Reserve and a deal with Democratic lawmakers for more fiscal stimulus. ‘There will be liquidity available, whatever we need to do, whatever the Fed needs to do, whatever Congress needs to do. We will provide liquidity,’ Mr Mnuchin said… Mr Mnuchin said he was in constant contact with Jay Powell, the chairman of the Federal Reserve, as well as US business leaders, about mitigating the impact of the spreading disease.”
Crude collapsed 25% Monday. Bitcoin collapsed 41% during the week. For the week, palladium collapsed 37%, platinum 17% and silver 16%. Gold dropped 8.6%. Sugar and Cattle were down almost 10%, as the Bloomberg Commodities Index sank 7.8% for the week. The S&P500 dropped 7.6% Monday; rallied 4.9% Tuesday; fell 4.9% Wednesday; sank 9.5% Thursday; and surged 9.3% Friday. Circuit breakers were triggered at least twice – and I don’t recall anything quite like it, even during 2008. It was a week when, to those paying attention, the potential for a crisis much beyond the scope of 2008 became readily apparent. We witnessed more than a glimpse of how global financial collapse could materialize.
March 12 – Financial Times (Gillian Tett): “This decade, America’s equity market has been like a drug addict. Until 2008, investors were hooked on monetary heroin (ie a private sector credit bubble). Then, when that bubble burst, they turned to the financial equivalent of morphine (trillions of dollars of central bank support). Now, in the wake of Thursday’s historic equity market crash, they must contemplate a scary question: has this monetary morphine ceased to work? Think about it. Ever since 2016, the Federal Reserve has tried to wean the markets off its quantitative easing measures and ultra-low rates. But whenever markets have wobbled — as they did last year in the repurchase sector — the Fed always returned with a new monetary fix. That has helped to sustain a startling bull market in equities and bonds.”
“Coordinated fiscal and monetary stimulus” – Wall Street’s new catchphrase. Aggressive fiscal stimulus has begun – with deficits already running at 5% of GDP. Rates could be cut to near zero next week – with the unemployment rate at 60-year lows and stocks only four weeks from all-time highs. QE will begin in earnest, with the Fed’s bloated balance sheet at $4.222 TN – having expanded $500 billion over the past six months.
I’m reminded of how a few highly-levered mortgage companies filed for bankruptcy in 1998 (after the LTCM crisis) without ever missing a Wall Street earnings estimate. It’s full crisis-management mode without even a negative GDP print. I certainly appreciate the seriousness of the unfolding crisis. But I do ponder what the government response will be after the Bubble has deflated and policymakers are confronting a deep recession and financial calamity.
With all the put options and hedges in the marketplace, I don’t doubt the capacity to incite a short squeeze and higher market prices. But I doubt fiscal and monetary stimulus will resuscitate the Bubble in global leveraged speculation. Illiquidity and market dysfunction have been exposed. Huge losses have been suffered and “money” will flee popular (and overcrowded) leveraged strategies (i.e. risk parity). I also suspect confidence in derivatives has also likely been shaken. Liquidity risk will be a persistent for global markets.
It started with Alan Greenspan imagining the wonder of market-based finance – with a little helping (visible) hand from central bankers. I referred to the “Moneyness of Credit” throughout the mortgage finance Bubble period. With the implicit backing of the federal government, the GSEs and Wall Street luxuriated in the capacity to turn endless risky mortgage loans into perceived safe and liquid “AAA” securitizations and instruments. Money – with the perception of safety and liquidity – enjoys insatiable demand. When it comes to financing runaway Bubbles, “money” is incredibly dangerous.
“Moneyness of risk assets” has been fundamental to my global government finance Bubble thesis. Dr. Bernanke collapsed interest rates, forced savers into the securities markets, and repeatedly employed the government printing press (QE) to backstop the markets – in the process nurturing the perception of safety and liquidity for stocks, corporate Credit, government bonds and derivatives. An enterprising Wall Street was right there with ETFs, index funds, “passive” investing, myriad derivatives and other low-cost products for speculating on the ever-rising stock market. Risky securities and financial structures were transformed into perceived safe and liquid “investment” products. Only a moron doesn’t believe in buying and holding like the great Warren Buffett. Cash is trash. Disregard risk and avoid active managers that invariably underperform index products.
It was history’s greatest speculative Bubble – and it has burst. “AAA” wasn’t risk free – and this recognition changed everything. Those levered in “AAA” were suddenly suspect. Perceived money-like liabilities (repos, derivatives, securitizations, etc.) abruptly lost their “Moneyness” and the run was on.
Myriad perceived safe and liquid financial instruments/strategies lost their Moneyness this week (fiscal and monetary stimulus notwithstanding, I don’t think it’s coming back). The run was on. With risks illuminated, leverage must come down. The “hot money” is now fleeing countries, markets and instruments – marking a momentous change in the flow of finance and global marketplace liquidity.
The critical issue is not so much the coronavirus and its economic impacts, as it is the uncertainty associated with the pandemic as a catalyst for the piercing of history’s greatest global Bubble. We’ll get through this, but the world is today poorly prepared for the great challenges it now confronts.