Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Oil price war spikes volatility with credit crisis echoes of 2008
Peter Garnry
Chief Investment Strategist
Summary: Brent crude was down as much as 31% in early session digesting the shock of an all-out oil price war between Russia and Saudi Arabia. Equities are down across the board as the oil price war and Italian lockdown are increasing the probability of a tough recession and potential credit crisis only 12 years after the world was dealing with one. We expect policy action from the Fed maybe even today and that the EU will soon have to make a coordinated statement to calm markets.
The OPEC+ meeting collapsed on Friday with Russia not willing to participate in the suggested production cuts that in the eyes of Russia would give US shale producers more market share. Nervousness lingered all Friday with equities and oil selling off, but Saturday Saudi Arabia surprised everyone announcing that it would increase production and accept lower prices. Brent crude oil futures opened 15% lower and was down as much as 31% at the lows. The shock spilled over into equities and credit with Japanese and Australian equities down 8% in one session.
To make things worse the Italian government announced yesterday that it’s putting 16 million people in Northern Italy in lockdown to combat the spread of COVID-19. Other European countries will likely follow as people’s behaviour is not changing fast enough to contain the spread. This will obviously make the economic impact even worse despite signs are emerging that China is getting back to decent production levels and car congestion levels in major cities such as Beijing and Shanghai. China took a massive economic hit from shutting down a large part of the country and while the country is now ready to produce the is likely moving to a state where it’s not ready to buy. The Japanese Economic Watchers Survey Expectations Index plunged to 24.6 in February which is only surpassed during the 2008 financial crisis.
S&P 500 futures went limit down overnight at 2,819 and has attempted twice to resume trading before being closed again. If S&P 500 futures hit 2,718 today it will be the fastest decline from peak to bear market (-20%) eclipsing other historical plunges such as 1929. The VIX Index and front-month VIX futures have hit 2008 levels suggesting further declines and extreme volatility. Our view is that the risk of a new credit crisis due to COVID-19 and the oil price war has increased dramatically and last week we highlighted which companies were most vulnerable in such scenario. Among industries banks, leisure (cruises, travel and hotels), automobile, airliners etc. are most vulnerable to lockdowns.
The market is now in panic mode which creates many non-linearities in markets and society, so there will be a policy response today. Our Chief Investment Officer Steen Jakobsen has put out an update this morning calling for the Fed to cut by 50 bps potentially today already. Given the severity of COVID-19 in Europe we also waiting for a coordinated response from the EU but history from the euro crisis suggests unfortunately that it will be slow and impotent until the house is really on fire. With weak banks and a car industry in full-blown crisis mode the Germans will have to act soon but the political chaos in Germany may prove a roadblock to big for a large response putting Europe at great risk here.
Bear markets and financial stress always have periods of rallies and eventually some segments of the equity markets will be like a candy store for kids. Our next update out later today will feature two bounce back baskets with equities that makes sense to get exposure to when the policy response reaches a size that offsets the pain from COVID-19 and improves the outlook at the margin. Stay tuned.
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