Market Insights – April 14, 2020

Each week, a team of experts shares its market views with you.

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Essentials

Prime Minister Shinzo Abe declared a state of emergency in Tokyo and six prefectures last week in an attempt to reduce the risk of a second wave of coronavirus infections. He also unveiled a stimulus package amounting to a record JPY 108 trillion, or 20% of GDP – much more than during the 2009 financial crisis.

Gold hit a new recent high of USD 1,765 an ounce. Sentiment is riding high in the short term and should continue to be buoyed by government stimulus plans in the longer term as well.

Opec announced that it would cut output by around 10 million barrels a day by May. This welcome move should prevent inventories from swelling too quickly but won’t balance out supply and demand before the summer.

Lower-quality bonds are making a comeback

Fears over the COVID-19 outbreak quickly spread to the bond market. Investor sentiment collapsed when the outbreak became a pandemic and it was clear that drastic confinement measures would be required to slow the virus and ease pressure on health-care systems around the world. The prospect of a serious short-term economic crisis led to widespread selling, as investors sought to rid themselves of all assets that could be considered risky. Higher-risk segments of the corporate bond market have been hit hard because of the impact that the economic crisis is expected to have on these issuers, especially in terms of their worsening credit quality and increased risk of default. This caused risk premiums on lower-quality bonds to rise sharply. It took decisive action on the part of the two largest central banks to calm the bond market as it started to show signs of stress. During these challenging times, central banks appear to be subscribing to the same principle of caution that has been guiding the response to the public health crisis. In an effort to keep the capital market liquid and accessible to most issuers, the European Central Bank (ECB) has come to the rescue of peripheral EU countries that have been hit hard by the pandemic, while the US Federal Reserve has lent a hand to the huge US corporate bond market for the first time in history. The Fed has had to bend its rules slightly, as shown by its recent decision to support even the riskiest companies by buying junk bonds. The massive amounts of liquidity injected into the markets should keep a large number of issuers solvent until economic growth can stage a comeback later in the year. After reaching their highest levels since the 2008 crisis, risk premiums on lower-quality corporate bonds have started to shrink again. We expect this trend to continue, and these bonds – especially high-yield US corporates – should outperform sovereign debt.

Europe : une réponse sans précédentEurope – an unprecedented response

Over the past few days, the coronavirus pandemic seems to be stabilising in Europe, which could mean that it has passed its peak. Some countries are even getting ready to gradually ease the lockdown. There is no shadow of a doubt that the public health crisis will cause major economic damage in Europe. Compared with previous crises, however, policymakers have been very swift to react and have brought in extremely far-reaching measures. First, the ECB showed that it was ready to do whatever it takes to prevent another sovereign debt crisis. Then came the fiscal stimulus: most European countries have pledged more money than they did during the 2008 crisis. The EUR 500 billion rescue package announced by EU finance ministers was a welcome move that will provide a further boost to this fiscal stimulus. Taken together, these actions should prevent the crisis from triggering a depression. Once the lockdown is over, activity should bounce back considerably, underpinned by certain consumer spending segments that will be buoyed by the increase in household savings and by delayed demand.  We think the stock markets will remain volatile until the worst of the uncertainty is behind us. However, given that we have already seen a very sharp correction and investors are pessimistic, we are seeing buy opportunities for investors with an investment horizon that goes beyond the current pandemic.

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