After the fall…

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March’s sell-off was an episode most of us will want to forget but now the dust has begun to settle on a generation-defining event in financial markets, perhaps it’s time to take stock. Here, Paul Benson (PB), Head of Fixed Income Efficient Beta, and Dragan Skoko (DS), Head of Trading and Trade Analytics, both of BNY Mellon Investment Management, offer their take on the sell-off and how it impacted fixed income.

Q: What was your experience of the sell-off?

DS: It was all-encompassing – as unprecedented in its scale as it was in the speed of its volatility. Bond market performance was mixed. Intermediate and long-term US treasuries performed well, while corporate bonds sold off, including investment grade corporates. High yield debt was hit the hardest.

Q: How did the sell-off mutate over time?

PB: Fixed income was able to withstand February’s initial spike in volatility but by the beginning of March, investors began to get spooked by the rising coronavirus numbers. It was at that point we saw the start of large outflows from corporate bonds into treasuries or cash.

Q: Which sectors were worst hit and how did that affect liquidity?

DS: Flows were negative virtually across the board, with record outflows in high yield, investment grade corporates and municipals. This created a feedback loop where fixed income mutual funds and ETF managers were forced sellers of their own portfolios to meet redemptions.  With too many managers trying to exit similar positions at once there was an imbalance between buyers and sellers, and an extremely disorderly market.

PB: There’s no question the outflows created liquidity problems. Corporate bonds are a good example. There are over 20,000 publicly registered bonds. In calm markets, less than 1% of them actually print daily. During March, those bonds just weren’t trading. That was making it impossible to correctly price individual bonds. That was the root cause of the cash markets breaking down.

How were bond ETFs affected?

DS: The liquidity problems meant many bond ETFs began trading at large discounts to their underlying assets. Corporate bond prices dropped in early March, but bond ETFs fell further, which led to the large differences between the price of ETFs and their assets. The liquidity crunch also affected bid-ask spreads, as their spreads widened. Commercial paper, which is issued by companies to fund their short-term obligations, also faced liquidity issues.

What was the Fed’s response?

PB: Initially we had rates cut to a target range of 0% to 0.25% then the Fed announced a US$700bn quantitative easing program. Then they announced that they were going to purchase investment grade corporate bonds and investment grade tax-exempt bonds as well. This enhanced liquidity and led to a bond rally in late March. This also improved confidence in the markets. The Fed came in with its arsenal of firepower and essentially helped the markets to function again from a liquidity perspective – and that’s exactly where we are now.

The quick Fed response has created a template on how to handle liquidity issues in the bond markets during periods of high volatility or any future market sell-offs.

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