Global central banks are scrambling to counter a major market downturn induced by the coronavirus outbreak by cutting already-low interest rates, with several moves this week, and more anticipated.
Most notably, the US Federal Reserve shaved off a larger-than-expected 50 basis points on March 3 to bring the federal funds rate range to between 1.0% and 1.25%. On the same day, the Reserve Bank Australia's 25bp reduction took it to a new record low of 0.5%, while Bank Negara Malaysia cut by 25bp on March 4.
And more of the same is expected from monetary authorities in both developed and emerging countries, including the European Central Bank (ECB) and the Bank of England.
Such action comes amid a worldwide stock selloff. The US's S&P 500 and the MSCI World index have plunged some 10% since February 20, when the number of cases in South Korea rose sharply and the country confirmed its first death.
In turn, investors' rush to safety has further pushed down yields on safe-haven government bonds (see chart below). One-year US Treasury yields have taken a particular hit, while their 10-year counterparts slipped to historical lows on the same day. They yielded 0.48% and 0.92%, respectively, on March 5.
We asked investment experts late last week which assets are likely to benefit from this challenging backdrop, and whether there are areas to avoid over a short-to-medium-term horizon.
The following extracts have been edited for clarity and brevity.
Dwyfor Evans, head of Asia-Pacific macro strategy
State Street Global Markets
Current conditions will support further monetary and fiscal easing, although the lead-lag structure from fiscal policy to the real economy will continue to favour monetary stimulus. This matters from a portfolio perspective in that relative asset performance depends partly on the transmission from easier monetary policy, and while we are dialling back on risk appetite we continue to see relative plays in both equities and fixed income.
The best opportunities in equities lie in those areas that have the room and the will to ease policy most. We thus remain overweight emerging market equities, with a bias towards China. US stocks offer the best quality and are relatively insulated from the virus – for now. Japan and Europe are where we see the greatest downside risk in equities, given their policy tools, both monetary and fiscal, are limited.
Fixed income also holds opportunities in markets where there is scope for rate easing – Canada and the UK – although again Europe (bunds) are potentially problematic, given the modest room for manoeuvre by the ECB. That limited space for policy adjustment is a supportive crutch for currencies, and we continue to favour safe-haven FX – euro and yen – as opposed to currencies in markets where central banks continue the easing cycle.
Thomas Poullaouec, Asia Pacific head of multi-asset solutions
T. Rowe Price
It is rare for the Federal Reserve to cut rates outside its normal policy meetings, but the Covid-19 outbreak created conditions for this material change to happen. While the sentiment of relief after the first few days of the cut has provided some immediate support to risky assets, it is still unclear whether an emergency rate cut can provide the traditional Fed put to reassure the markets, and if there will be transmission to the real economy.
Looking past the immediate market reaction, the US yield curve has steepened materially since the cut, yet yields continued to decrease. Such a 'bull steepening' is not a positive sign for economic growth. This means investors should remain defensively positioned with treasuries, gold or more defensive sectors within equities.
However, if yields start to move higher, we could experience a bear steepening similar to that of mid-2019 after the Fed changed course. Higher yields would be painful for bond investors. In that environment, risky assets such as equity and credit could perform. Both conditions could happen depending on time horizon. In the short term, the momentum in treasury yields and the high-volatility environment could exacerbate the bull steepening scenario.
For longer-term investors who can look past the coronavirus outbreak, it is likely that a bear steepening would occur. If that’s the case, maintaining an overweight to risky assets at the expense of bonds would be appropriate. Investors should monitor treasury yields in the US and Germany, as well as copper, oil and gold prices, among other indicators, to evaluate when the market is expecting the bull to go away and the bear to come to the rescue.
Jamie Stuttard, portfolio manager and head of global macro fixed income
The Fed’s 50bp rate cut was not only bigger than expected, but also sooner, being the first inter-meeting rate cut since 2008.
We expect most central banks in advanced economies to take official rates to the effective lower bound. Some may consider joining the negative interest rate policy club. If so, markets would look to price that in before it occurs.
US duration has clearly had tremendous momentum recently, with the magnitude of yield moves beginning to rival those during the 2008 global financial crisis and already eclipsing those during the 2011-12 sovereign crisis. From a global perspective, we see front-end duration opportunities in South Korea and New Zealand and, over a longer horizon, Chinese government bonds.
In credit, we think US leveraged loans and CCC-rated bonds are the most vulnerable parts of fixed income markets in the near term. Eleven years of increased leverage and the threat of recession don’t tend to go well together.
But further out, credit markets are repricing towards more attractive levels. Typically, once a US recession is fully priced in, including default rate expectations of 10% in high yield, investors can expect attractive strategic entry points, which we may see later this year.
Sean Taylor, Asia-Pacific chief investment officer
Regarding fixed income, our view on bonds has shifted slightly. After strong demand for government bonds in recent days and a corresponding fall in yields, we have turned neutral on the US from overweight and remain neutral German government bonds.
In view of the market weakness in recent weeks, we have increased our weighting to higher-yielding bonds – in particular euro corporate bonds, as valuations look attractive and the ECB’s buying programme should provide structural support.
On US high-yield bonds and emerging-market government bonds, we have moved back from neutral and await a better entry level. We have gone overweight Italian sovereigns after their spreads have widened.
In respect of equities, we believe earnings forecasts for this year will be revised down noticeably but that higher price-earnings multiples will result from lower interest rates.
From a sector perspective, we downgraded financials due to the faster-than-expected change in US rates and the gloomy growth outlook, but upgraded healthcare due to attractive valuations and easing US policy headwinds.
We are looking for entry into emerging markets due to their attractive valuations relative to developed markets. EM earnings fell sharply in 2019 due to the trade war, and we were expecting a recovery this year, but the Covid-19 virus will delay this recovery.
We are overweight Brazilian domestic stocks, as they are likely to benefit from local interest rate cuts, and also overweight China and South Korea. We are underweight Taiwan, Malaysia, Thailand and the Philippines.
On the alternatives side, the low-interest-rate environment should be supportive for gold, used as a hedge.
Previous market views on the coronavirus outbreak:
Article updated to clarify T. Rowe Price comment on 'bull steepening' of yield curve.