Investors Confront the Stark Reality of the Coronavirus
High yield credit spreads widened sharply on the week, rising 167 basis points to the highest in four years. Treasury bond yields rose as liquidity concerns overwhelmed worries about the economy. The yield on the ten-year climbed 20 basis points to 0.96 percent, while the thirty-year rose from 1.29 to 1.54 percent. In an effort to alleviate the pressure in the Treasury market, and provide support overall to the economy, on Sunday, the Federal Reserve lowered the Fed funds rate to zero, just two weeks after cutting the same rate by one-half percent. At the same time, it announced an increase in its bond buying activity in both the Treasury and mortgage-backed securities and made it less onerous for banks to borrow from the discount window.
The Gravity of the COVID-19 Outbreak Hits Home
The seriousness of the COVID-19 (coronavirus) outbreak has finally hit the U.S. Suspensions of NBA, NHL and MLB seasons, March Madness, the closing of schools, the shutting of restaurants and bars, and restrictions on travel are reinforcing the message that social distancing is a critical weapon in the battle to slow the spread of the virus. But it only works if people take it seriously, unlike the situation in China where the government can more or less make it happen. The cycle of the virus in the U.S. is likely to accelerate and peak over the next two months, or so.
The news on the number of new infections and deaths is likely to rise significantly, especially as the frequency of testing increases. And ultimately, the resulting slowdown will begin to show up in economic data. It wasn’t until roughly mid-February that the virus hit our domestic radar screen as a potential threat. Prior to that it was primarily a China problem. And the reality of the domestic impact has really only hit home recently. So, the data will not truly reflect the domestic economic impact until we see some March and April data. This week we will get February reports on retail sales and industrial production, as well as several reports from the housing sector.
China Reports Weaker-than-Expected Data; Monetary Policy Can Only Do So Much
On Monday, China reported some of its February results, which were far weaker than expected. Rather than falling by the consensus 4 percent, retail sales fell 20.5 percent. Industrial production was expected to drop by 3 percent, but instead fell by 13.5 percent. And fixed investment fell 24.5 percent, rather than the expected 2 percent.
Despite the Fed’s Sunday rate cut, and despite Friday’s powerful rally, U.S. futures are pointing to a sharply lower open. European stocks are sharply lower as well. The ten-year note yield is back down to 0.76, giving back all of its increase from last week. Domestic crude oil has fallen below $30 a barrel for the first time in four years.
Investors realize that monetary policy can only help so much in this situation, and that the fiscal response needs to be considerably larger than what we have seen so far. Whether politicians in Washington and elsewhere understand that remains to be seen. Sizeable fiscal packages have been announced in some countries, including South Korea, and the U.K. Germany has said it will provide whatever is needed. But clearly, more will be needed if markets are going to stabilize, especially while the number of infections continues to rise, and lives are disrupted by social distancing.
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The Standard & Poor’s 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices but excludes brokerage commissions or other fees.
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options.
An index is a statistical composite that is not managed. It is not possible to invest directly in an index.
A 10-year Treasury note is a debt obligation issued by the United States government that matures in 10 years. The 10-year yield is typically used as a proxy for mortgage rates, and other measures.
The 30-Year Treasury is a U.S. Treasury debt obligation that has a maturity of 30 years.
A mortgage-backed security (MBS) is an investment similar to a bond that is made up of a bundle of home loans bought from the banks that issued them.
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- Chief Market Strategist, Ameriprise Financial
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