- Long-term US Treasury bonds have rallied 134 basis points over the past 7 weeks as the coronavirus contagion grows.
- For the first time ever, the entire US Treasury yield curve is at sub-1% yields.
- Both investment grade and high yield corporate bonds have lagged as recession fears increase.
Hand sanitizer is not the only commodity in short supply due to the outbreak of the coronavirus.
Since late January, when the first case of the virus was reported in the U.S., investors have not been able to buy enough long bonds. Interest rates on 30-year bonds have fallen by 134 basis points in seven short weeks. On Friday alone, the 30-year US Treasury bond rallied 25 basis points, the largest one-day drop in 12 years. Today, bonds broke that record, rallying another 34 basis points. That’s a 59-basis point drop in two days! Long rates are now at an all-time low of 0.98%.
Interest rates across the yield curve have fallen by similar amounts. Yields are now at the unheard of level of under 1% for the entire US Treasury curve.
The demand for bonds is the result of a flight to safety, as investors fear that the expanding virus will dramatically impact economic growth. The robust jobs report of Friday, with unemployment ticking down again to 3.5%, tying the 51-year low, is viewed as old news. Instead, expectations of a recession are rising with each new report of virus contagion.
The Fed expressed its concern by cutting the Fed Funds target rate by 50 basis points on Wednesday, March 3rd. This was the first inter-meeting emergency rate cut by the Fed since the financial crisis of 2008.
The upcoming Treasury auctions of $78 billion in new coupon securities this week ($38 billion 3 years, $24 billion 10 years and $16 billion 30 years) will be but a small relief to satiate market demand. New record low auction rates are expected at each maturity.
While demand for US government bonds has been strong, the same cannot be said for all segments of the fixed-income markets. Corporate debt spreads have spiked. The Markit CDX North American Investment Grade Index of CDS spreads almost tripled, from 43 basis points to 110 basis points. Clearly, there has been a turn in the credit cycle, as corporate earnings prospects have worsened as the economy contracts. The gapping of spreads is indicative of an increased chance of corporate defaults.
The Markit High Yield Index of CDS spreads widened almost 300 basis points to 551 basis points. The high yield market is suffering even more from recession fears.
This hit to the corporate market was compounded over the weekend with Saudi Arabia’s surprise announcement of a sharp cut in crude oil prices as it raises production. Oil prices fell 25% today alone and are off more than 50% from the high in January, only 2 months ago.
The impact on travel due to the coronavirus, combined with the Saudi oil price cuts, is leading to a crash in stock prices. Today’s 7.6% drop in the S&P 500 puts the index within spitting distance of a 20% decline from the highs of less than 3 weeks ago. That is the definition of a bear market.
The shortage of bonds is evidenced by the lack of yield in fixed-income instruments. Negative-yielding debt has risen to $14.5 trillion from $11 trillion in January. This represents almost 25% of the global bond market. The recent moves in the Treasury market are causing some to think that negative yields are heading to the US bond market as well.
Total Negative-Yielding Debt in the Bloomberg Barclays Global Aggregate Index
In fact, negative yielding securities have already appeared. Treasury Inflation-Protected Securities (TIPS) yields dipped negative following the Fed easing last week, as seen below. The 30-year TIPs are currently at -0.23%, the lowest on record. While TIPS are only a small part of US Treasury marketable debt, representing 8% of the total, they may foreshadow what’s to come.
Despite last week’s 50-basis point rate cut, the Fed is lagging the market. The target Fed Funds rate now stands at a range of 1.0-1.25%. This is the highest point on the yield curve, as all Treasury rates are below 1.0%, with 12-month bills yielding just 0.28%. The market is pricing in another Fed Funds rate cut at the March 18th FOMC meeting.
It is not clear, however, that cutting rates will solve the problem. In some ways, it is like pushing on a string. Monetary policy is not an effective tool at combating the spread of the coronavirus. The Fed is better served ensuring the stability of the financial system during this period of extreme volatility. Today, it announced an increase in cash injections for banks to guard against market pressure. The Fed is increasing the amount it offers in overnight operations from $100 billion to $150 billion. In addition, it is increasing its two-week repo offerings from $20 billion to $45 billion. The Fed’s statement said the move is “íntended to ensure that the supply of reserves remains ample to mitigate the risk of money market pressures that could adversely affect policy implementation.”
As for the original question, “Is there a shortage of bonds?” the answer may be that it depends on what kind. Clearly, the flight to safety has driven government bond yields to record lows. If demand continues, we are perilously close to approaching negative yield territory. Yet other segments of the bond market seem in more-than-ample supply. Spreads on credit products have gapped open as fear of recession has muted demand. Weakened corporate issuers may not be able to roll over maturing issues.
While demand for government bonds may continue in the near term, it is hard to imagine that there are many investors who perceive sub-1% yields as good value over the long term. Also, it is difficult to reconcile a shortage of government bonds with record budget deficits looming for the foreseeable future.
This article was written by
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