This Multi-Phase Crisis Can Be Navigated if We Join Forces to Thread the Needle

The COVID-19 Crisis Delivers Three Economic Shocks

  • It has been a market of exceptional volatility. Lost in the headlines is the fact that we were at all-time highs in risk assets just three months ago. With the arrival of COVID-19, we have suffered the repercussions of three shocks.
  • The first is supply shock, which began with the news out of Wuhan. American businesses have been scrambling and struggling because we could not get all of the parts, supplies and inventory we need from China and emerging Asia. That shock has largely passed, as China starts to ramp up.
  • The next shock is the demand shock, which Americans are currently living through as we shelter in place and reduce or cease consumption, which has put many service providers, businesses and jobs in limbo. For example, we saw demand shock hit the oil market, only to be further exacerbated by a price war between Russia and Saudi Arabia.
  • These two shocks (supply and demand) culminate in a financial shock, marked by a massive drain on liquidity as everybody rushes for cash. The level of uncertainty and volatility is rather high and comparable to 2008 in several ways.

Financial Shock Warrants Further Discussion

  • Because we are talking about fixed income, I want to talk at greater length about the financial shock that has two component phases of its own.
  • The first phase involves a liquidity crisis, which history shows follows a somewhat predictable pattern: everyone is grabbing for cash, while investors are selling what they can and not what they should.
  • This is hitting all sectors of the market, but is especially hitting the less-liquid sectors. Therefore, it began in credit and high yield, while investment-grade spreads shot up like a rocket. More recently, it struck the non-agency mortgage market. There are headlines that several mortgage REITs will be unable to satisfy mortgage calls.
  • We’re actually seeing this liquidity shock occur globally. Indications of non-U.S. stress can be gauged by the U.S. dollar. Despite our dramatic reduction in rates and Fed actions, the dollar is up, though off its highs.