Ian Burdette stared at his computer screens on Thursday afternoon in New York and could
hardly believe his eyes. Everywhere that the head of term-rates trading at Academy Securities
Inc. looked, there were massive anomalies and signs of unprecedented stresses in markets.
Ultra Long Term U.S. Treasury Bond Futures, which moved about 1.3 points per day on
average in January, were down more than seven points on the day and off 36 points from
Monday’s high. Italian sovereign debt had simply imploded. An index of costs to insure
corporate debt with credit-default swaps surged the most since Lehman Brothers collapsed,
and the CBOE Volatility Index measuring costs to hedge against losses in U.S. stocks was the
highest since November 2008.
In almost every single market, the difference between bid prices from buyers and ask prices
from sellers was soaring. The spreads had become, Burdette said, “astonishingly wide.”
“There are so many flashing sirens on my monitors, I don’t know which is the worst,” said
Burdette.
As the novel coronavirus continued to spread this week to become a pandemic, financial
markets went into a tailspin and rekindled concerns about their ability to function in times of
crisis. This is the first major test for the markets since reforms that were introduced after the
financial crisis curtailed banks and brokerages from being able to provide liquidity during a
turmoil –- in other words, to be a buyer and seller to clients when they need it most.
The market upheaval is exacerbating volatility across assets as investors struggle to determine
what they’re actually worth, while the economic outlook grows more dire by the day and
uncertainty still surrounds the real impact of the virus.
The evaporation of liquidity was evident across virtually all asset classes, but its absence was
most stark in securities which normally serve as havens and see their prices increase during a
turmoil. That caused strange, unsettling moves as traders watched long-established crossmarket relationships disintegrate.
Treasury 30-year yields unexpectedly rose after their swiftest declines on record, while gold
tumbled, even as stocks suffered their sharpest one-day plunge since 1987. The cost to trade
Treasuries spiked and order books thinned out to a degree last seen during the 2008 financial
crisis.
“We were just trying on Monday to trim a long position in the 30-year Treasury because it
had moved so far in our favor and we were unable to get bids from several major dealers,”
said Mark Holman, chief executive officer at TwentyFour Asset Management in London, who
has been working in the business since 1989. “Dealers don’t have the risk appetite and budget
they normally have. But I’ve never seen that before, the inability to trade a U.S. Treasury. And
I’m pretty sure I’m not the only one who experienced this.”
Fixed-income exchange-traded funds became unhinged from the value of the assets they
invest in, often at unprecedented rates. The top five largest bond ETFs traded with discounts
to their net asset values that were either records or the biggest since 2008. The $23 billion
iShares 20+ Year Treasury Bond fund’s price ended Wednesday 5% below the value of its
assets. In the almost 18-year history of the product, the average difference between its price
and the value of its assets has been 0.03%.
Even the usually quiet world of municipal bonds saw eye-popping volatility. Vanguard mutual
funds that invest in municipal bonds from New Jersey and California suffered their worst oneday declines on record, while a New York state muni fund had its worst decline since 1987.
The VanEck Vectors High Yield Municipal Index ETF, which holds the debt of hospitals,
nursing homes, airports and other borrowers, closed Thursday at a price that was 19% below
the value of its assets.
Untangling all of the causes of the various stresses in markets may prove to be difficult, if not
impossible. Still, an overwhelming demand for U.S. dollars from corporations and investors is
blamed for drying up liquidity. Many companies are being forced to tap emergency credit
lines from banks to ensure they have enough cash on hand to continue operating as their
revenue streams threaten to dry up.
That is being exacerbated as investor demand for new corporate debt offerings disappears.
Funds that invest in U.S. investment-grade corporate bonds suffered their worst outflow
on record while investors also retreated from U.S. high-yield and leveraged-loan funds,
according to Refinitiv Lipper data. The combined cash withdrawal reached $14.3 billion,
exceeding last week’s $12.2 billion record.
“Thursday was a perfect paradigm of the situation we are in,” said Tad Rivelle, chief
investment officer for fixed income at asset manager TCW Group Inc. “Basically everything
was sold: stocks, all forms of debt, Bitcoin, gold. It looked like a big margin call. You are
seeing a large shift in investor preference away from anything besides cash.”
The mad dash for U.S. dollars introduced rarely seen levels of stress into foreign exchange
and funding markets. Currency volatility nearly touched levels last seen in 2008 and demand
to bet on a rally in the yen over the coming week in the options market hit a record. Rates in
cross-currency basis swaps, in which one party borrows in one currency while
simultaneously lending the same amount in another currency to a counterparty, are signaling
overwhelming demand for dollars. Similar stresses are being seen in swap spreads that
exchange fixed rates for floating rates on bonds.
Treasuries Liquidity Drying Up Puts $50 Trillion in Question
“This is a liquidity squeeze I haven’t seen since the Lehman crisis, not even during the
European debt crisis,” said Shinji Kunibe, general manager of global strategies investment
department at Sumitomo Mitsui DS Asset Management Co. in Tokyo. “Strateɒy is for flight-tocash, flight-to-liquidity.”
Some of the stresses were alleviated Thursday and Friday after the Federal Reserve said it’s
prepared to inject a total of more than $5 trillion in cash into funding markets over the next
month to ease the cash crunch. It also started to purchase Treasuries across the yield curve.
While the Fed’s moves may not prove to be a panacea that cures all of the various markets’
ills, it should at the very least alleviate the need for banks, corporations and investors to
hoard dollars.
“We don’t think this can turn around risk sentiment; it can’t prevent the upcoming slowdown
in consumption and economic activity,” said Elsa Lignos, global head of FX strateɒy at RBC in
London. “But it does mean that financial markets don’t need to hoard liquidity in the way
consumers have been hoarding tissue paper and pasta. It shows the Fed has learned the
lesson of 2008: pump in liquidity.”
— With assistance by Alyce Andres, Katherine Greif
