March 9, 2020 / 9:17 AM / 25 days ago

Daily Briefing: Sell-and-run grips world markets

LONDON (Reuters) - Virus contagion is spreading far and wide, shocking markets, and today the 30% crash in oil prices engineered by Saudi Arabia has set in motion the kind of market plunges that have not been seen for years.

A man wearing a protective face mask stands near an electronic display showing the Nikkei index outside a brokerage in Tokyo, March 9, 2020. REUTERS/Edgard Garrido

Just take a look at some of the moves - U.S. equity futures are down 5% and European shares opened 10% down. U.S. yields are at 0.35%% - down 150 basis points from early January and continuing their march towards zero.

German yields have fallen 10 basis points past their previous record low. Currency volatility, dormant for so long, has well and truly woken up, with euro-dollar vol at over 10% — almost three times mid-January levels.

The problem, aside from the fact that the virus is turning up in all corners of the world, including the world’s biggest financial capitals, is uncertainty – how bad will it get, how much it will damage economies?

China’s January/February trade figures showed exports falling, but it was already outdated. So was Friday’s U.S. payroll figure which elicited little reaction from markets.

German industrial output will probably be a similar picture. People are also wondering how trading can continue if regulators shut down markets even partly or put in place work-from-home orders. The latter is entirely new.

The U.S. in particular looks like uncharted territory, with infection rates on the rise and President Donald Trump still insouciant about the risks. Those are some of the reasons for the sell-and-run swings we are seeing today.

The drama is unfolding on many fronts: Oil’s plunge could tip many oil-exporting countries into deep trouble and a swathe of U.S. shale firms into default. Stock and bond markets are witnessing a massive flight to safety.

Corporate credit distress will almost certainly grow, especially in junk-grade debt and the lower-rated oil producers and associated industries. Implied default probabilities are soaring and the iTraxx crossover index of junk-rated European companies has almost doubled since the end of 2019.

JPMorgan analysts reckon that the number of “fallen angels” — companies that have just lost investment-grade status — is at six so far this year. At that rate, the total for the year will be 35, not far from 2015 levels, the year of the big China equity crash and devaluation and following the 2014 oil collapse.

With consumer spending down on all manner of things, except perhaps toilet paper and hand sanitisers, the damage to corporate cash flow is going to be tremendous. Record-low interest rates provide a cushion, but even the most adventurous investors will hesitate to refinance companies whose balance sheets will be covered in red ink. 

Italy is another front. Already the most fragile of the major economies, its richest area is under virus lockdown and could thrust its finances closer to the precipice.

This morning, 10-year Italian yields are up almost 30 basis points and the spread over German debt — the premium investors demand to hold Italian risk – has ballooned out past 200 basis points.

Finally, we have money markets, the plumbing that ensures world financial systems run smoothly. Stresses are showing as companies and countries that borrowed overseas scour markets for dollars, whether for trade finance or coupon payments.

There were some signs of this in swaps markets, where borrowers look for dollars if they can’t get them through the usual channels.

It seems nothing will pacify markets but a coordinated government and central-bank response, and one that incorporates fiscal stimulus. With interest rates at rock bottom, there is nowhere to cut. Policymakers have made noises in that direction.

For instance, the Boston Fed’s Eric Rosengren suggested on Friday that the Fed could consider a facility that could buy a broader set of assets. The Bank of England's incoming governor, Andrew Bailey, suggested linked monetary and fiscal stimulus.

The oil plunge is front and centre for emerging markets. The rouble is down nearly 7%, the Mexican peso down 6.5%, rand down nearly 4% and Middle East currency forwards are getting whacked - essentially bets on devaluation are gathering force.

Emerging-market corporate spreads have surged to highest since January 2019 as default worries grow. The Institute for International Finance estimated emerging markets were seeing record outflows even before the oil rout.

And speaking of defaults, Lebanese bonds are down to 16 cents in the dollar as the March 9 bond is unlikely to be paid.

— A look at the day ahead from EMEA Deputy Markets Editor Sujata Rao. The views expressed are her own —

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