SPDR : Time to go back in the water? Potentially – with convertible bonds

SPDR :  After Composite PMIs cratered to 27.5 at the beginning of the month, European and US PMIs followed the same path with prints between 30 and 40, along with abysmal confidence numbers..

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SPDR ETF (Espresso)

A good portion of developed economies are now ‘staying at home,’ with the exception of essential functions, and the economic impact could be dire if the situation persists. While China seems to be on the other side of the peak, the country still faces a lack of demand, which could delay any pick-up in activity.

Nevertheless, coordination on the monetary and fiscal side over the past 10 days has assuaged markets somewhat. As highlighted by our colleagues in their recent note , continued coordination is needed on many fronts: provide resources and policy to suppress the epidemic, support income through fiscal packages, inject liquidity via QE, coordinate multilateral agencies, and enable development banks to support EM countries.

While economic data will continue to disappoint, many measures have been announced by G4 central banks (and others) that have helped markets recover and spreads tighten. But rating downgrades will start to exceed upgrades, and earnings revisions may put pressure on the rebound that started on 24 March.

So is it already time to go back into the markets?

The case for:

  • Fiscal measures are significant in both size and breadth in the US and Europe and soon will be in Japan as well.
  • Central banks have thrown everything they can at COVID-19.
  • ECB: €750 billion PEPP (pandemic emergency purchase programme) and OMT (outright monetary transactions) could be activated, potentially allowing central banks to deviate from the capital key (i.e. the amount of buying allocated to each country) and keeping Euro area sovereign bond yields in check.
  • The Fed’s QE is going as far as including corporate bond ETFs and will last until at least September – it’s coming on top of the $700 billion already announced – and it will provide up to $300 billion in new financing to employers and consumers. It establishes two facilities to provide credit to large employers – the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
  • Numbers of COVID-19 cases and deaths, while high and increasing, show some signs of curbing in countries that started the lockdown earlier, e.g. Italy.

The case against:

  • Some fiscal measures, though in place, may be too slow to avoid large rises in unemployment and defaults, which would drag down sentiment and consumer spending.
  • Default rates will increase and earnings revisions may not be fully priced in, calling into question whether assets are cheap in high yield and equities.
  • The number of COVID-19 cases may slow in initially affected countries but it will likely peak later in the US, UK and Germany. And without global coordination the countries that are on the other side of the curve are now closing themselves to foreigners, for example as announced by China this week. So lockdowns could last longer than anticipated.

What have convertible bonds done so far and what can they offer for a cautious comeback in the markets?

Since the beginning of the recent market turmoil, global convertible bonds have played their role in protecting to the downside of equity exposures. And thanks to a lower exposure to energy, convertible bonds have outperformed high yield corporate bonds, notably US high yield.


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