Coronavirus Infects Global Financial Markets
With the passage of the Phase 1 U.S.-China trade agreement in late 2019, U.S. economic data in early 2020 had been trending in a positive direction. In fact, the Atlanta Fed’s latest weekly GDPNowTM forecast for first quarter 2020 growth exceeds 2.5%. Importantly, the Federal Reserve’s cuts to its target fed funds rate range last year helped boost housing activity and support healthy spending among domestic consumers. Risk appetites appeared strong, with U.S. equity indices touching all-time highs and credit spreads across both investment grade and high yield narrowing. But that was all B.C. (“before coronavirus”).
While it might feel like the markets got sucker-punched in the last week, U.S. Treasury yields began to reflect a less sanguine outlook a month ago. The slope of the 3-month bill/10-year note curve briefly inverted in late January and moved decidedly negative by mid-February, as markets began to anticipate successive rate cuts from the Fed over the balance of 2020. The breakeven rate on U.S. Treasury Inflation-Protected Securities (TIPS) started the year around 180 basis points (bps) and began to fall precipitously as oil reached a technical bear market. At the same time, the global supply of negative yielding debt, per Bloomberg Barclays indices, rose to over $14 trillion.
Markets despise the “unknown-unknown,” and the COVID-19 virus, caused by a member of the coronavirus family that’s a close cousin to the SARS and MERS viruses of past outbreaks, presents a number of challenges to forecasters. An early indication of the virus’s economic impact across China was revealed last night, as the country reported official purchasing manager index readings that showed dramatic contractions in both the manufacturing and non-manufacturing surveys. It appears likely that growth across Asia will continue to slow, perhaps significantly, and as yet, it’s difficult to determine for how long. We believe this slowing growth will have ancillary effects across supply chains for companies in both developed and emerging markets. This is reflected in the OECD’s overnight 50 bps cut to its global growth forecast for 2020 to 2.4%.
Global central banks appear to be readying policy responses, with Fed Chairman Jerome Powell releasing a brief statement on February 28 that helped ease market turmoil. Treasury rates have rallied significantly on expectations that a cut in fed funds rate will occur at or before the next scheduled meeting on March 17-18.
We’re Maintaining Our Discipline and Executing a Risk-Focused Plan for Our Clients
While we certainly didn’t anticipate the outbreak of COVID-19, we planned for potential sources of volatility heading into 2020 by positioning client portfolios more defensively. We actively de-risked portfolios by lowering credit exposure, particularly out the curve and in lower-quality sectors, based on the strong performance and historically tight spreads reached in 2019. Escalating trade tensions late last summer gave us opportunities to begin adding exposure to the high-quality agency mortgage-backed securities (MBS) sector. We are now overweight agency MBS, and we believe these up-in-quality trades position our clients more defensively, which is prudent given the current elevated uncertainty. While we continuously evaluate opportunities across all sectors, we remain vigilant of risk/return trade-offs as we seek to protect capital in more volatile market environments.
PNC Capital Advisors, LLC is an SEC-registered investment adviser, offering an array of investment strategies. PNC Capital Advisors, LLC is a wholly owned subsidiary of PNC Bank N.A. and an indirect subsidiary of The PNC Financial Services Group, Inc. PNC Capital Advisor’s strategies and the investment risks and advisory fees associated with each strategy can be found within Part 2A of the firm’s Form ADV, which is available at https://pnccapitaladvisors.com.
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