Fixed Income Market View

March 9, 2020

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Given all that’s going on, we thought we’d provide a few thoughts on the macro environment and then on fund positioning (Diversified Bond Fund & Credit Income Opportunities Fund).

Prior to Friday, this market sell off was primarily driven by Coronavirus fears (supply and demand shock, leading to an economic slowdown, risks of global pandemic, recession, etc). We have shared our thoughts with sales last Saturday on this topic.

This is by no means gone, and we still think that things will get worse before they get better. The market has been slow to internalize the effects of the virus and we thought there was another leg down/shoe to drop when the infection rate was going to increase in the US. This was happening late last week, and is behind the very large drop in interest rates and widening of credit spreads we have seen. Until now, credit was behaving very well (vs equities).

As if that wasn’t enough, the Russians and Saudis have decided to start an oil price war. Eric has sent you plenty of material on that topic during the weekend, so I won’t discuss the specifics of that in more details.

The repercussions of this huge decline in oil prices, compounded with the already weakening macro backdrop have the potential to inflict a lot of damage to credit markets, with feedback to the real economy.

Lower oil prices impact the economy and credit markets in a few ways:

  1. Lower prices at the pump (this positive impact doesn’t matter much right now because people are not travelling)
  2. Energy companies and investment: big part of US and Canadian CAPEX is from oil and gas. This is certain to decline even further now.
  3. We will likely see bankruptcies in the oil patch à banks will tighten credit, similar to the 2015/2016 episode.
  4. There’s a lot of large bond issuers that are rated BBB or BBB-, and those have they potential to get downgraded to junk, putting further stress on HY indices.
  5. Mechanically, lower energy prices mean lower expected inflation, and thus lower bond yields.

-interbank Funding spreads show signs of stress (3m LIBOR – OIS)

Source: Bloomberg 

Investment Grade Credit spreads are jumping higher. The pace of this move is unprecedented. We are close to 2015/2016 highs, in the space of a week.

Source: Bloomberg

This puts further pressure on central banks to prop up the economy and make sure credit and money markets stay well oiled. (pun intended).

This morning, the NY Fed announced a new round of term funding.

They will probably need to do more.

At the time of writing, the futures market is pricing in 3 cuts by the Fed next week. That would effectively take us back within 1 rate cut of the zero lower bound.

It is then no wonder that government bond yields keep plunging; we have the Fed expected to take rates to zero, inflation expectations collapse because of the decline in oil prices and a strong bid for safe heavens.

I think it is fair to say that global recession risk is high and rising.It will take time for the effects of the coronavirus to pass. We will eventually find a vaccine,  and the most vulnerable will probably get a flu shot and a covid-19 shot in the fall. But for now we have to deal with the human and economic fallout from it.

What does that all mean for the funds?

In the Diversified bond fund, we had been cautious coming into the year. Our credit exposure was low and higher in quality, and we had some government bonds to offer ballast. We bought more government bonds (US 30y) on Friday afternoon, as we feared things might get worse over the weekend.

In the credit opps, we had also derisked the portfolio; leverage is low, we are short HYG about 8% of the portfolio, which offers ballast.

Credit is getting cheaper and at some point there will be bargains worth buying. We have lots of liquidity. We are building a shopping list as we speak. Not ready to pull the trigger yet, but we have to be ready to buy good credits for cheap when the time comes.

Bottom line: we are well positioned for this and stand ready to act from a position of strength.

The Bond Team: Mark, Etienne and Chris

Ninepoint Partners

1 All Ninepoint Diversified Bond Fund returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at February 28, 2020 1 All Ninepoint Credit Income Opportunities Fund returns and fund details are a) based on Class A units (closed to subscriptions); b) net of fees; c) annualized if period is greater than one year; d) as at February 28, 2020.

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