Perspectivas
Emergency Fed Cut: Not a Vaccine, but a Treatment for Symptoms
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Market Pulse
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marzo 03, 2020
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Emergency Fed Cut: Not a Vaccine, but a Treatment for Symptoms
Emergency Fed Cut: Not a Vaccine, but a Treatment for Symptoms
Emergency Fed Cut: Not a Vaccine, but a Treatment for Symptoms |
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On March 3, the Federal Reserve cut rates by 50 basis points (bps) to between 1-1.25%. The first rate cut made between scheduled policy meetings since the Financial Crisis, the move is intended to maintain economic momentum in response to the growing Coronavirus threat. What should fixed income investors make of this move?
Coincident global rate cuts, not coordinated. But not all eases are created equal!
- The Fed has scope to cut policy rates, but…
- Other central banks can buy credit and even equities, while the Fed cannot.
- A Fed rate cut ‘signals’ support and keeps borrowing costs low.
- But that’s not enough. The Fed needs to ensure credit transmission to real economy
- Fiscal policy relief may be ultimately what’s needed -- insurance, paid leave, TALF (Term Asset Backed Loan Facility), TARP (Troubled Asset Relief Program) and more creative ideas
As a result, Fed policy must be viewed through the lens of financial conditions, which are comprised of:
- Equities, BBB credit spreads, short rates, intermediate rates (10y) & USD
- A rate cut can more directly address rates (lower) and USD (weaker) ✔, but…
- …it cannot address credit or equities directly. Our belief is credit is most important!
The key risk is credit. For this we apply an AAA framework – Affordability, Accessibility, Appetite.
- Affordable. Fed rate cuts keep corporate borrowing rates low.
- Accessibility. Will technical/structural factors enable corporate borrowers to issue debt?
- (Risk) appetite. Will there be demand for buying corporate bonds?
- If credit transmission to the real economy falters, then this becomes a systemic problem vs. idiosyncratic. In our view, this is what the Fed needs to address most!
The BIG risk is with the SMALL corporations
- Small- and Mid-sized Entities (SMEs) are more at risk of losing access to credit and rolling over loans than larger corporations that have access to capital markets.
- SMEs tend to borrow from local banks and use personal credit, such as credit cards, to use as working capital.
- SMEs account for approximately 65% of jobs, which leads to consumption, which is about 70% of GDP.
- Regulatory pressures may need to ease for large banks to provide liquidity to smaller banks.
- The first place to look is for signs of stress in the repo markets. The Fed needs to avoid this at all costs. There are no signs of this at the moment.
If credit conditions remain fluid, then the make-up for a sharp recovery exists
- If not, then recovery may take much longer.
- Time is the enemy… it erodes credit quality as measured by debt/EBITDA.
Risk Considerations
There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default, and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. High-yield securities (“junk bonds”) are lower-rated securities that may have a higher degree of credit and liquidity risk. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. Foreign securities are subject to currency, political, economic and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk).
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Managing Director
Global Fixed Income Team
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