Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Optimism Reigns on Not Much
Summary: In contrast to emerging real economy destruction, the week begins on a positive note, as COVID-19 case growth appear to be slowing in most developed world countries. At the time of writing US futures are making a beeline for limit up and Asian indices firmly green, ASX 200 +4.33%, Nikkei 225 +4.44%, KOSPI +3.75%, Hang Seng +2.29%.
Italy, the new hotspot Spain and the UK have all reported a decline in the daily death toll, from a humanitarian perspective this is great news. President Trump also appears to have dialled back the severity of his warning, at the latest COVID-19 White House presser stated the outbreak was perhaps “levelling off”. "We see light at the end of the tunnel. Things are happening," Trump said, however we would still caution that the road ahead (or tunnel) is long and winding. A levelling off of cases could be more akin to the end of the beginning, rather than the beginning of the end as the real economy effects play out.
When it comes to the real economy effects and second order impacts of the COVID-19 containment measures, these show no sign of levelling off making the days exuberance look rife with complacency. This as Japan moves to declare a state of emergency April 7, Singapore locks down once again and pockets of emerging markets stresses show little sign of abating. The pressure of dollar strength and funding squeeze continues, although swapped lines have helped and dollar borrowing premiums have lessened. The sharp devaluation across multiple EM currencies may eventuate unintended economic dislocations that have capacity to spark risk whilst sentiment remains fragile. Flexible exchange rates will absorb the economic shock to a point before presenting secondary consequences.
A level off in the toll on humanity, whilst very welcome, is different to containment measures being lifted and a move toward resumption of normal activity. And even as lockdowns are lifted it is likely social distancing measures remain in place putting an added dampener on resumption of activity. Moreover, as Fridays, March payrolls data indicates hiring subsided even prior to lockdowns, highlighting the unprecedented shock to labour markets and freefall in demand that is just beginning to unfold globally. Providing a glimpse of what is to come in April, which will no doubt be nothing short of ugly, +10% unemployment is feasible as payrolls drop significantly. Putting this all together and as Peter writes, gauging the earnings and dividend profile yet to emerge, equities have continued downside to price. We believe it is premature to ascertain that the negatives have been sufficiently discounted.
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