Boston - From a macro perspective, I believe the most acute part of the financial panic is behind us. There is much less talk of unsettling events that took place in March, like bid-wanted lists coming out on weekends and fund liquidations. Investors are now looking more at how COVID-19 will affect macro fundamentals and how that could drive markets going forward.
There still could be more downside volatility ahead in the markets, because the fundamental outlook doesn't look good. For example, last week the markets were strong, but the week prior, not so much. The ebb and flow will likely correspond to sentiment about COVID-19, the current economic downturn, and the timing and slope of the potential recovery, but it is always difficult to predict what the market will focus on a day-to-day basis.
The latest moves from the US Federal Reserve last week involved the creation of a Municipal Liquidity Facility, and its decision to purchase so-called fallen angels in the high-yield market as well as high-yield ETFs.
These moves illustrate how the Fed has been very focused on two things. The first has been getting the markets to work better, and I believe it has succeeded. The second is bridge finance — getting us from where we are today to where we need to be. Expect the Fed to continue to be aggressive with such programs and tweaking them until it is satisfied they are working.
Progress in Europe
In Europe, the European Central Bank (ECB) has also had a strong policy, in which it announced the Pandemic Emergency Purchase Program (PEPP) to buy both government and corporate bonds. There has been talk about a more aggressive joint initiative from European fiscal policymakers, though the typical core-periphery divide, as well as the challenge of making a consensus decision that always seems to plague Europe, has held back some of the proposals.
That said, last week the eurozone finance ministers in the Eurogroup reached a deal that included three programs that will provide favorable financing to member states, worth up to €540 billion. The deal is a positive step as it showed compromise between Italy and the Netherlands. No additional economic conditionality will be attached to the European Stability Mechanism (ESM) credit line, and the finance ministers agreed to work on a recovery fund. However, there is still no commitment from members to share the costs of the crisis. There is the potential for the recovery fund to include explicit transfers to the countries that are most impacted and there will be some support to fund it with "coronabonds," although we still remain doubtful that northern countries will agree to mutualized debt issuance.
Mixed news for emerging markets
In terms of emerging markets (EM), it's kind of a mixed bag. The good news is that valuations, particularly EM local-currency assets are quite attractive with EM currencies weak and the dollar strong. The same holds true for local EM interest rates: Spreads are fairly wide across the yield curve, relative to developed markets (DM).
The second positive relates to the Fed's dollar liquidity swap program, which is designed to prevent the US dollar from getting too strong. That is definitely a positive for EM countries as there appears to be an emerging global policy consensus that a too strong US dollar is not in anyone's interest. With the International Monetary Fund (IMF) and World Bank (WB) Spring meetings occurring virtually this week, there may be some more announcements coming out that potentially help US dollar liquidity access for EM countries.
The biggest challenge for many EM countries is that they are not as well equipped to combat COVID-19 as the developed world. For example, health care capacity is not up to the same standards and maintaining physical distance is often much harder. EM governments will be more hard pressed with monetary and fiscal responses than their DM counterparts, though so far much of the EM world has been able to ease monetary policy in the face of this economic shock, which was not always the case for EM countries.
Bottom line: These all translate into serious fundamental concerns for EM investors, especially in terms of debt sustainability. On April 15, finance officials of the G20 agreed to suspend debt service payments for the world's poorest countries from May 1 through the end of the year, reportedly freeing up more than $20 billion for the fight against COVID-19. There were also discussions this week about further relief, at meetings of the IMF and the WB whose officials praised the decision by the G20.