The Fed’s rate cut was not the most clear-cut answer to the corona crisis, says Hendrik Tuch, head of fixed income at Aegon Asset Management.
But he understands the decision.
‹It anticipates on investors receiving terrible economic figures and profit warnings in the coming weeks. I’m talking about PMIs of 30 or even 25. Against that background, it’s important to counterbalance the negativity that will result from this,› says Tuch.
‹Seen in that light, I don’t think it’s so strange that central banks are now lowering interest rates.›
Bond market back on track
‹The Fed can’t make the coronavirus go away, but the point is not to excaberate volatility in the market. Companies need to be able to continue to fund themselves.› After all, there were no bond issues at all last week as a result of the corona crisis. Immediately after the emergency cut of the Fed last Tuesday, they resumed. According to the Financial Times, a dozen new bond issues were announced in the US and Europe on Wednesday. The interest rate cut therefore had an effect, but according to Tuch this doesn’t make it an economically necessary step.
According to the fixed income specialist, spreads on investment-grade bonds have widened around 25 basis points over the past two weeks, and are now at their highest levels since September. But is that enough reason for the biggest interest rate cut since the financial crisis? After all, yields are currently lower than they were at the beginning of the year, with the exception of certain parts of the high-yield market.
‹In general, we don’t see a very large divergence between, for example, A-rated credits and BBB. It is mainly companies that were already struggling anyway, such as car manufacturers, that are taking a beating,› says Tuch. ‹Renault and Kraft Heinz, for example, were already downgraded to high yield in January. That was before the coronavirus surfaced.›
‹Companies such as LVMH and Kering have a taken a hit on the stock market, but credit investors look through the coronavirus disruption because these companies will get through two weak quarters as they have strong balance sheets. One can therefore indeed wonder whether the Fed should have intervened so quickly, and whether a rate cut would have been the most effective means,› concludes Tuch.
The ECB should therefore not follow the Fed’s example. ‹Lowering interest rates is difficult for them anyway, of course, but raising the QE programme is possible. I can imagine a doubling to 40 billion euros a month next week.›
‹Help SMEs’
However, this would mainly help investors and large companies, while it is SMEs that would be hit hardest by the coronavirus.
‹A specific ECB programme for SMEs would therefore be most effective, possibly combined with measures to stimulate bank lending. After all, you want to prevent massive SME bankruptcies in Italy. It’s the likes of restaurant owners in Rome who are suffering most,› he says.
Moreover, there is already light at the end of the tunnel. In China, the number of new corona infections is decreasing, and economic activity seems to be on the rise again. And investors are anticipating a rebound. The Shanghai Stock Exchange has already made up most of the losses of the past month and a half.
‹Good entry point for credit’
So is it time to add risk again? Tuch certainly thinks so. High yield spreads have widened by 100 basis points in recent weeks. We also see clients taking the oportunity to add. If they were planning to increase credit exposure anyway, now would be a good time to enter.›
In spite of his optimism, Tuch keeps some reservations. ‹It’s possible that China, and later Europe as well, return to normality a little too quickly, enabling the virus to make a comeback. We may also see that investors will continue to reduce positions as the number of infections keeps rising quickly in Europe over the following days.›