Fixed Income View: A Crisis Like No Other

When times of turmoil hit, most investors become risk-averse, seeking safety over opportunity for higher returns. The coronavirus-driven crisis is no different in that regard. However, John Beck, our director of fixed income, London, sees some striking differences between this and other crises, and offers some thoughts on where he thinks taking some risk today might make sense.

From a financial market perspective, the events that have unfolded over the past few months in response to the outbreak of COVID-19 are truly unique. While some have compared this crisis to the global financial crisis (GFC) in 2008-2009, one big difference is that the GFC represented a problem with the “plumbing” so to speak. It emanated from problems within the financial system that caused banks to stop lending and liquidity to dry up. The coronavirus outbreak was not related to any issues within the financial system, but rather, a health crisis which led to government lockdowns which brought a forced, sudden stop to economic activity in many countries at the same time.

But when any crisis hits, the one thing investors tend to do is avoid risk. There are not many assets today that are generally perceived to be risk free, but US Treasuries, German government bonds, UK Gilts and Japanese government bonds fit into that category.

Lower for Longer Yields Likely

While a number of economies have quickly contracted, it’s uncertain if a recovery will be equally as quick. We believe it’s unlikely that it’s going to be a V-shaped recovery—that is, a sharp recovery from the trough. We are hoping it’s not going to be an L-shape, marked by a more prolonged economic downturn.

At the outset of the crisis, in a previous blog we suggested central banks would likely apply the same oath doctors swear to, the Hippocratic oath, which is to “do no harm.” And we believe they will continue to try to abide by that Hippocratic approach even after things start returning to normal. While central banks have been very quick to support the markets, I think the removal of some support measures will be slow, in line with our view of a likely gradual economic recovery.

The traditional central bank response to a resumption of more robust economic activity would be to raise interest rates. But we don’t think we will see yields move up very quickly; for investors hoping to see a 5% yield again, it looks quite distant. In our view, an economic recovery is also going to take some time. Volatility always spikes around these types of events, and we are seeing that in some of our risk metrics. Therefore, a gradual decline in volatility would be an encouraging sign.

Looking at how sovereign bonds have fared, there are differences; for example, in Spanish, Italian and German government bonds. Part of that is due to the initial impact of the virus on those individual countries, and the local government reactions. The ramifications of the heavy fiscal spending on individual economies will differ, as some had better or worse fundamentals, including debt-to-gross domestic product (GDP).