The Fed and the Bank of England responded to the coronavirus fall-out with emergency rate cuts of 50 basis points. Now, all eyes are on the ECB.
‘Hopefully, these drastic interest rate cuts will prove to be an overreaction by policymakers. Unlike during the financial crisis, cheap money cannot solve this problem,’ says Jim Leaviss, CIO of M&G›s Public Fixed Income Team. Anyway, it’s unlikely the ECB will mimic their fellow central bankers’ policy response, because it’s policy rate is already deeply negative at -0.5%.
M&G expects the ECB will take a different course, by stepping up its quantitative easing programme. ‘Currently, net asset purchases amount to 20 billion euros per month. But this amount could easily be increased to EUR 80 billion, as was the case from April 2016 to March 2017, including a significant proportion of corporate bonds’, says Wolfgang Bauer, a fixed income fund manager at the UK asset manager.
Corporate bond investors would undoubtedly welcome such a move. But investors should still beware, warns Bauer. ‘If the corporate bond market calms as a result of the ECB›s intervention, a wave of new corporate issuance put on hold during the recent sell-out could hit the primary market, and the sheer volume of the new bond offering could prevent a narrowing of credit spreads.’
Government bond overweight
Besides, corporate bonds are of course not immune to the turbulence in equity markets and fears about the economy. ‘I have had little exposure to corporate bonds for months because I believe the asset class is expensive, although fundamentally strong because defaults are extremely rare at the moment. When the market sold off last week, I bought some corporate bonds, but I am still extremely underweight,› says Leaviss.
‘As the impact of the virus lead to increased volatility, the associated uncertainty will increase the demand for safe-haven assets,› he believes. Leaviss therefore maintains a strong overweight to long- duration government bonds. ‹I currently have my longest maturity since the Great Financial Crisis because I aggressively added government bonds in January as valuations had become more attractive and economic growth had begun to stagnate.’
Is there any good light at the end of the tunnel? If we look far enough to the east, we can see dawn, Leaviss believes. ‘Chinese economic figures are sometimes viewed with suspicion, but we do have some access to some real-time measurements of activity there, such as data on pollution and traffic congestion. These suggest that the reported levelling off of virus cases there could be real, and that the economic slowdown could be shorter if the rest of the world can quickly isolate suspected virus cases. Hopefully that’s what’s going to happen.›