How bond markets are responding to stress and stimulus

30 March 2020 | Markets and Economy


In this short video, Tim Buckley, Vanguard's CEO, and Sara Devereux, head of global rates, discuss what's behind the bond market liquidity crunch.

Tim Buckley: Sara, you're a key leader in our fixed income group. You head up our rates team and you help set all of our active strategies in fixed income. You've also had decades of experience. We've both been in this business for decades. We've seen turmoil in the bond market before, but this one is a little bit different from other ones we've seen. Usually you'll see dislocation in prices. You're going to see spreads widen, you're going to see it in high yield. Maybe in some investment grade. But this turmoil is echoed almost across all parts of fixed income, so maybe give us a little idea of what are you seeing and what kind of crisis is this and what's behind it?

Sara Devereux: Sure. I think it's predominantly a liquidity crisis. It started in the Treasury market about two weeks ago. We started to see dislocation in off-the-run Treasuries. Now these are securities that typically trade right on top of each other. Very similar yields but we were seeing divergence in pricing. These were early signs that there were liquidity problems.

Tim: That's an odd place to see it first, right? The Treasury market.

Sara: That's right.

Tim:  I mean that's supposed to be the best credit out there. Very liquid market. You wouldn't expect to see it there.

Sara: That's right, and it was certainly a warning sign. We noticed it. The Fed noticed it. And they took immediate action. By that weekend, they had announced several measures to address the problem, including quantitative easing in large size. They specifically cited they wanted to address the liquidity in the Treasury and the mortgage market. And then they upsized that QE program and they announced additional facilities to address liquidity in other markets, such as corporate credit, municipals and even our money markets.

Tim: Because if you look at investment grade, the spreads there in BBBs had widened significantly. They weren't trading very well either, right?

Sara: That's right. This was a problem that was across all asset classes in fixed income, and it was surely a balance sheet problem, some clogs in the system in getting liquidity to flow.

Tim: But let's back up a little bit like what's causing this? We've got the Covid-19 crisis. You've got an economic slowdown. You've got a lot of companies, well, they don't know how long they're going to have to last without being able to go get revenue so to speak. So they're going to cash.

Sara: That's right. At times of stress, everybody wants cash. Corporations need it to pay their employees. Banks need it to make loans and there's demand for cash. And typically raising cash is a very smooth exercise in the markets. This time was different simply because of the sheer speed of the crisis and the magnitude of the liquidity that was demanded. Frankly, the banking system, the plumbing isn't set up to accommodate this size of flows.

Tim: But if we get liquidity back, you avoid a liquidity crisis becoming a lasting credit crisis. Fair enough?

Sara: I totally agree. And not only that, by the Fed stepping in and providing liquidity in the markets, it's good for market functioning, but it also keeps borrowing rates low, which is critical to get us through this period for consumers and for companies to have access to funds to bridge this crisis and get to the other side.

Tim: So I think about our investors and one thing they don't want to do is sell into this. The corporations, they have to sell down and accumulate cash because they have demands on their business. As you mentioned, paying their employees, paying their power bill, etc etc. They've got a much higher burn rate than an individual. An individual hopefully has their cash reserves and then they can wait to tap into their other investments. So if you're selling into a liquidity crisis, you're probably selling at a distressed price. Fair enough?

Sara: I totally agree with that.

Tim: So maybe if they can, if you can afford to, better to wait than to panic now.




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