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What's happening with bonds and corporate debt?

Hi Cullen and Co,

I a few questions about the bond and corporate debt market (they are quite newbie in nature) but i'm trying to better understand the newsflow so i can separate fact from faction.

1. I keep hearing that there's massive bond market sell-off, but wouldn't people want to flock to bonds at time of recession risk?  Does this suggest people have sovereign risk concerns?

2. The Fed and other central banks are pumping liquidity into the market via QE/similar tools. This should increase the price of bonds (as bonds and other instruments become relatively more scarce) and lower yields. But if bonds are selling off, yields are rising?

3. Why was the oil tug-of-war the catalyst  for the credit markets to get spooked? So lower prices help consumers but will effect explorers and oil companies, thereby hurting there margins and increasing the risk of a credit event? How does that percolate to the rest of the market. Is it that credit markets (along with equity markets) re-calibrated their view of the world such that they saw COVID-19 + Oil tug-of-war as becoming widespread, and hence would effect large swathes of the economy and therefore yields on corporate debt increased (pricing in greater risk)?

Sorry quite a few questions, i know, but i'm try to get a better grasp of fixed income and its implications for equities, etc.

 

Thanks,

Alex

LOTS going on here.

Most of the declines in the credit spectrum are pure solvency concerns. The oil thing is problematic because many oil firms are leveraged. The Saudis are basically trying to bankrupt US Shale producers. That's a big deal because there's a lot of outstanding credit in the shale space.

COVID is a different beast altogether. This is like nothing we've ever seen before. It's shutting down entire industries so you have borrowers who are going from AAA status to literally having no income. It's unreal. The only safe place in credit is US T-Bonds because the US govt isn't having a solvency crisis.

This is a historic event. Something no one predicted. And no one knows how it will turn out....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Thanks Cullen- this was helpful.

And the bond sell-off can be explained by the fact many fund managers are being forced to liquidate positions quickly (with treasuries being v.liquid) to meet redemptions?

 

Relatedly, I'd be interested to get your thoughts on portfolio construction in this environment, perhaps that's something for another blog post.

Separately, i find the strong sell-off in listed property somewhat puzzling; traditionally seen as a stable vehicle in a period of crisis, given long leases and relatively secure income stream (contractual). I understand the sell-off in say retail REITs (like Simon Property Group), given quarantine, store closures, tenant stress and tenant demand for rent relief (no cashflows). But interesting to see the sell-off in other reit sectors. On pure valuation / value, many bargains to be had but they feel like traps given the volatility and velocity of these market drops.

I guess as you said this is "unprecedented", a health crisis first which requires some stabalisation in COVID-19 case no (like in China), before any fiscal or monetary stimulus can truly appease the market.

From where I sit in Sydney, Australia, the US looks to be on the precipice of a massive MMT experiment. We will likely do something similar (although so far i think our government pledged c.1% of GDP - maybe more now, i hope! v.~5% of GDP in '08, when our then labour government helicopter dropped money into the hands of all Aussies)

Thanks Cullen.

Hi @alexv,

The decline in economic activity is causing a funding crunch. The system isn't really designed to seize up like this. It needs a constant flow of money to function well. Otherwise mortgages don't get paid, banks stop getting cash, they tighten up lending, and the the whole things seizes up. You need that cash flow all the time. So this is a jarring event across the system.

As for portfolio construction - I am an advocate of countercyclical indexing. That's the strategy I run for my clients. It's held up very well during this downturn. I discuss my general philosophy in this paper:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2740027

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche