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BMT Monday Market Insights – May 18, 2020

Market Insights

Top Weekly Themes

  1. Federal Reserve corporate bond buying begins – The Federal Reserve (Fed) added to its list of bond purchases last week after dipping into the corporate bond market and buying eligible exchange traded funds (ETFs) invested in corporate debt. The Fed’s actions are part of two programs announced in mid-March, the Primary Market Corporate Credit Facility, and the Secondary Market Corporate Credit Facility, both tailored to support liquidity to large companies. Since the bond programs were announced, bond market liquidity has substantially improved. Based on the Bloomberg Barclays Intermediate Corporate Bond Index, credit spreads dropped from as high as 381 basis points on March 23 to less than 200 basis points this past week. We believe credit spreads have room to tighten further but expect volatility to continue. Given the Fed’s participation in the corporate bond market, we expect that bond market liquidity will continue to benefit while also preventing credit spreads from retesting their recent highs.
  2. Consumer prices significantly drop in April – Business closures and lockdowns have certainly had an impact on economic growth. A drop in consumer and business spending can also lead to lower prices. In April, that was certainly the case. The consumer price index (CPI) dropped -0.8%, the second consecutive month of price declines. To be fair, lower energy prices were a significant contributor to the decline. However, when considering prices when excluding food and energy, the CPI still decreased -0.4%, the lowest on record. Although shocking, the numbers are somewhat explainable given the current situation. Importantly, we do not believe the current data is reflecting the beginning of a long-lasting deflationary period. Instead, as lockdowns begin to ease, and consumers resume more normal spending behavior, we expect prices to eventually reverse course.
  3. Anthony Fauci states risk of opening economy too quickly – Dr. Fauci spoke to a Senate committee last Tuesday regarding the coronavirus and its impact in the U.S. He noted his concerns about prematurely re-opening parts of the U.S. and its potential derailing of recent progress made in controlling the pandemic. Trying to find the correct balance between safely re-opening the economy while preventing another outbreak will be challenging, to say the least. Based on the market’s trading activity last week, it appears that investors’ optimism for a quick economic rebound may be waning. We continue to believe that brighter days lie ahead, but trying to predict the exact timing is difficult. For now, we believe stocks are pricing in a fairly optimistic outcome; although looking for opportunities (especially within fixed income) we remain on guard for another round of market volatility.

Returns Table

Week (%) YTD (%) 1-Year (%) 3-Year (%) 5-Year (%) Div Yield (%)
Equities
S&P 500 (0.9) (11.1) 2.7 26.6 49.0 2.04
Russell 1000 Value (1.9) (22.4) (12.5) (0.3) 13.5 3.24
Russell 1000 Growth (0.4) (0.9) 16.0 54.2 84.1 1.13
Russell 2000 (3.5) (25.4) (18.6) (6.7) 6.7 1.78
MSCI EAFE (1.8) (21.0) (11.5) (6.3) (4.0) 2.99*
MSCI Emerging 0.5 (18.7) (8.5) (2.3) (0.1) 2.85*
Week YTD 1-Year 3-Year 5-Year Yield 
Fixed Income
Bloomberg/Barc US Aggregate 0.0 4.9 10.2 16.2 21.3 1.32
Bloomberg/Barc US High Yield  (0.4) (8.7) (3.3) 5.6 18.5 8.14
Bloomberg/Barc Muni Bond  0.8 (0.2) 3.1 11.6  18.8 1.91
Bloomberg/Barc Global Agg. Ex U.S. (0.1) (1.7) 2.2 8.5 10.5 0.87
Week YTD 1-Year 3-Year 5-Year Current Level
Commodities
Crude Oil (WTI) ($/bbl) 18.4 (54.3) (54.9) (41.7) (53.4) 27.9
Natural Gas ($/mmbtu) (11.2) (23.2) (36.8) (50.9) (44.1) 1.7
Gold ($/ozt) 0.9 14.4 34.2 41.7 41.8 1,738.1
Copper ($/mt) (1.4) (16.3) (14.2) (6.6) (19.4) 5,155.5
1 Week Ago YTD 1-Year Ago 3-Years Ago 5-Years Ago Current Level
Currencies
Euro/USD 1.08 1.12 1.12 1.09 1.14 1.08
USD/YEN 106.57 108.68 119.58 113.24 119.23 107.05
Pound/USD 1.23 1.32 1.29 1.29 1.58 1.22

As of May 14, 2020 (close)
*Dividend Yield For MSCI EAFE and MSCI EM are from 4/30/2020.

Chart of the Week

Click the chart to enlarge it.

Two-Year U.S. Treasury Yield and Federal Funds Target Rate (December 31, 2007 – May 7, 2020)
Source: Bloomberg Inc.

Key Takeaways

  • The two-year U.S. Treasury yield reached a new record low of 14 basis points (0.14%) on May 7, a significant change from its beginning-of-the-year level of 1.57%. The record low can be partly attributed to investors pricing in some probability that the Fed may lean toward negative policy rates this year.
  • Short-term maturities are highly sensitive to the Federal Funds Target Rate (FFTR), a rate the Fed administers when conducting monetary policy. The Fed lowered it to roughly 0.0% this year, to lower corporate and consumer borrowing costs and promote economic stability.
  • As recently as May 13, Fed Chairman Jerome Powell reiterated that the Fed is not considering the use of negative interest rates. He reiterated that the use of other monetary policy tools would be more effective in promoting price stability and full employment, the Fed’s primary objectives.
  • We believe the likelihood of negative rates in the U.S. is low, and that the Fed will continue to resort to other policy tools to provide accommodative monetary policy. Forward guidance and quantitative easing have historically been effective in keeping borrowing costs low. Also recently, the Fed added to their existing playbook by announcing that they plan to buy individual corporate and municipal bonds.
  • The Fed also has the benefit of hindsight, analyzing economic implications and the cost-benefit relationship from other central banks that have executed negative policy rates, such as the European Central Bank and the Bank of Japan. Although widely discussed and debated, we do not believe the Fed will resort to negative interest rates.

Commentary

U.S. Treasury Total Public Debt Outstanding (December 31, 2019 – May 8, 2020)
Source: Bloomberg Inc.
  • Thus far, stimulus measures by both the Fed and the U.S. government have been noteworthy and unprecedented. Also, based on commentary, it appears that more may be coming.
  • Federal Reserve Chairman Jerome Powell provided an update on “Current Economic Issues” last Wednesday at the Peterson Institute for International Economics. He explained that the current economic contraction is much different relative to other U.S. recessions since the Great Depression, based on the “scope and speed of the downturn.”
  • The U.S. government has been issuing sizeable amounts of U.S. Treasury securities to help pay for recent and expected outlays to households and businesses. This week, the U.S. Treasury will auction a new 20-year Treasury maturity to help attract investors and fund their expected sizeable deficit this year. And while the U.S. Treasury is issuing more debt, the U.S. government is in the process of negotiating another potential trillion-dollar stimulus bill.
  • We believe the combined actions by both the Fed and the U.S. government will be critical in limiting the downside economic risk in the short-term. However, we also acknowledge that current measures are designed as short-term methods to bridge the gap between current economic distress and an eventual effective response/cure to the coronavirus.
  • We believe that much uncertainty remains. It’s important to note that financial markets can be forward looking, with investors looking beyond today’s dismal economic data. Although we remain optimistic about eventually resuming a path toward economic growth, we believe the process may be slower than investors anticipate.

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