Risk assets were significantly higher in April due to the flattening of the pandemic curve and substantial monetary and fiscal stimuli
Risk assets have rallied strongly since mid-March, albeit the pace of gains has moderated over the past three weeks. The effectiveness of social distancing measures vis-a-vis curbing the spread of COVID-19, as well as massive monetary policy stimulus, especially by the Federal Reserve, have succeeded in lowering risk and liquidity premia, driving equity prices higher and corporate bond spreads lower (see graph below for S&P500 Equity Risk Premium). Moreover, abnormal Price/NAV discounts evident in major corporate bond ETFs have normalised (see graph page 3). Finally, expansionary fiscal policy is expected to cushion the blow to household income due to the lockdown, aiming to support, through loans and grants, viable companies that experience liquidity mismatches.
Overall, the SPX has increased by 30% at 2930 since its trough in mid-March and has overperformed its Developed-market peers by a wide margin. Corporate bond spreads have recouped a significant portion of their COVID-19 widening (USD IG: 60%, USD HY: 50%, EUR IG: 40% and EUR HY:40%). Volatility has declined considerably, particularly in the Sovereign spectrum, as central banks have de facto committed to unlimited amount of purchases, at least as long as the pandemic distorts proper economic functioning. Equity and foreign exchange volatility has also subsided, albeit it remains above pre-crisis levels (see graph page 3).
As the post coronavirus re-opening begins gradually, we have constructed a Social Distancing Index (SDI) per basic economy based on Google’s community mobility report (see graph below). The report tracks movement trends over time across six different categories of places, but we choose to use the more relevant ones, i.e., i) retail and recreation; ii) groceries and pharmacies; iii) transit stations; and iv) work places. With the exception of Japan, SDIs of advanced economies have stabilised, but remain at very low levels, suggesting extreme values of social distancing. We expect these SDIs to gradually rise, albeit failing to revert to pre-coronavirus levels during the course of 2020. As a result, certain sectors/companies such as mass tourism, mass recreation, energy and materials, airlines and autos are expected to remain ultra sensitive to the underlying health of the economy.
The Federal Reserve expanded its balance sheet by circa $2.5 trillion to $7 trillion (30% of 2019 GDP) in the past two months, and committed to directly support the credit markets via its primary and secondary market facilities with a “firepower” of up to $750 billion. Moreover, after having cut its policy rates by 150 bps to 0%-0.25%, the Federal Reserve expects to maintain this range until it is confident that the economy has weathered the sharp decline in economic activity and the associated job losses, with futures pricing in zero rates for three years. Note that the US unemployment rate has risen sharply to 15% in April (see Economics).
On the other side of the Atlantic, the ECB expanded its balance sheet by €690bn to €5.5 trillion (40% of 2019 GDP) through its regular and pandemic-related asset purchases and loans (conditional and unconditional) to financial institutions. The recent ruling by the German Constitutional Court that both the European Court of Justice (ECJ) and the ECB had acted ultra vires with regard to whether the ECB’s decisions on the public sector purchase programme (PSPP) satisfy the principle of proportionality, inserted fresh bouts of volatility in the euro area periphery bond market at least for the next three months, on top of the deterioration in fiscal prospects for certain economies (see graph page 3). Nevertheless, the ruling came with mild positives such as the PSPP does not violate the prohibition on monetary financing. We expect the ECB to proceed relatively unconstrained in the short term, and do whatever is necessary to support the euro area economy, along with the European Commission, EIB and ESM (details regarding the Recovery Fund are expected in mid-May). Note that the ESM revealed the details of its Pandemic Crisis Support which provides broadly unconditional credit lines up to 2% of each euro area member-state GDP, at least until end-2022. The loans would have a maximum average maturity of 10 years with a margin of 0.10% per annum over ESM funding, an annual service fee of 0.05% and an up-front service fee of 0.25%.