This week wasn’t the best. We came into Black Friday with US equity markets recording their worst 1 day loss since October 1987…I was working for a merchant bank then and had to have some hard discussions with lenders to keep us afloat!

This major rout in the markets came from an already jittery financial market, capitulating when the WHO finally described COVID-19 a pandemic. "WHO has been assessing this outbreak around the clock and we are deeply concerned both by the alarming levels of spread and severity, and by the alarming levels of inaction. We have therefore made the assessment that COVID-19 can be characterized as a pandemic.” - World Health Organization 11 March 2020.

Friday afternoon, post the COAG meeting, Prime Minister Morrison announced that on medical recommendation, the government is banning gatherings of more than 500 people from Monday, to limit the spread of COVID-19. The Australian reported that “The Prime Minister said the guidelines would apply to non-essential, organised gatherings of 500 people or more, and would not include public transport, airports or universities.”

Black Thursday Turns into Black Friday

US markets were belted after the WHO finally upgraded the coronavirus to a pandemic, pushing the US stock market in an official Bear market. Stocks exposed to tourism, entertainment and oil were hardest hit on the expectations of major disruptions to earnings while COVID-19 spread escalates. Bonds rose in yield as markets grew restless as to why no meaningful fiscal response from Washington other than banning travel from Europe for 30 days, promising financial relief “for workers who are ill, quarantined or caring for others due to coronavirus”, and the Small Business Administration will make emergency low-interest loans available to affected businesses, and said the government will defer tax payments for certain individuals and companies for three months. The shape of the bond curve steepened as traders sold long bonds and bought cash out to 1yr maturities indicating a desire to keep high levels of liquidity.

Friday afternoon, saw Asia Pacific getting sold off heavily and the bond curve higher in yield back to levels 1 month ago.

All in all, tough times at present as we see more event closures where people are congregating. The Australian F1 got cancelled on Friday and as from Saturday Disneyland is closed. We wait and see, but with equity markets collapsing, there are bargains beginning to emerge…as they did in the depths of the GFC in 2008. The COVID-19 spread will continue to get worse and the financial markets will continue to over react as they fail to find liquidity providers (see below discussion on this point). 

Central Banks will continue to get involved, such as the US Fed on Thursday and Friday being in the market buying US$1.5 trillion of bonds from the market to inject cash into the banking system for short term liquidity management. If debt markets become closed to new debt issuance, then things become interesting and we may see forced asset sellers emerge. Late this week, the markets had increased debt margins by 25-35bp across the curve, however the comments made were these levels hadn’t been tested as borrowers were unwilling to lock in rates in this volatile environment.

Liquidity is fast emerging the unintended consequence of conservatism

The Federal Reserve was in the market pumping liquidity into the bond market to provide US$1.5 trillion in cash from buying back bonds. Liquidity has become an unintended consequence of the stock market sell-off in reaction to COVID-19. It appears to me that it stems from the overly draconian rules put in place on banks post the GFC to limit risk taking by applying heavy capital adequacy rules to trading books. This had the effect of closing down trading operations and capital was deployed to deemed safer investments such as mortgages and etc. The unintended consequence is that there are now bank balance sheets taking advantage of these massive market moves creating liquidity holes where market prices gap down.

“The Virus and the Australian Economy”

The Deputy Governor of the RBA, Guy Debelle spoke at AFR Business Summit on Wednesday about the COVID-19 and its potential impact on the Australian economy. Essentially he describes the current impact of the coronavirus on the economy, where the RBA is estimating an economic hit of circa -0.5% to March quarter GDP, just from the downturn in education exports and tourism. This is in addition to the RBA estimate of -0.2% to GDP from the bushfires across December and March quarters.

He notes that post the GFC and the fallout from loose lending practices, “The liquidity environment has changed considerably in the past decade in response to changed regulations. The banking sector is much less willing and able to warehouse risk and provide liquidity than in the past.” This is an unintended consequence of the banking system bailout we saw post GFC, and is perhaps now an admission that it is now left to central banks to manage price extremities as banks are no longer allowed to have the same risk tolerances to trade price extremes.

Debelle finally tries to put all this into perspective, by highlighting the globe will come through the coronavirus emergency, however it will take time and co-operation with government and central banks. He notes: “The effect of the virus will come to an end at some point. Once we get beyond the effect of the virus, the Australian economy will be supported by the low level of interest rates, the lower exchange rate, a pick-up in mining investment, sustained spending on infrastructure and an expected recovery in residential construction.”

Australia’s emergency economic stimulus package

Prime Minster Morrison announced the $17.6bn emergency economic stimulus package in response to the COVID-19 pandemic. Of the $17.6bn, $11bn is intended to be spent before 30 June 2020 so as to have maximum impact now. It is estimated to have a 1.5% GDP impact for the June quarter. There is a chance that the March quarter may show negative growth when combining the bushfires, floods, coronavirus and the general economic downturn.

Essentially the stimulus package was as pre-announced:

• Increase the instant write-off threshold from $30,000 to $150,000 and expand access to include businesses with aggregated annual turnover of less than $500 million (up from $50 million) until 30 June 2020. 
• 15 month (to 30 June 2021) investment incentive to support business investment and economic growth over the short term, by accelerating depreciation deductions. Businesses with a turnover of less than $500 million will be able to deduct 50 percent of the asset cost in the year of installation, with existing depreciation rules applying to the balance. 
• Up to $25,000 cash payment to employers with a minimum payment of $2,000 for eligible small and medium-sized businesses. The payment will provide cash flow support to businesses with a turnover of less than $50 million that employ staff, between 1 January 2020 and 30 June 2020. The payment will be tax free. 
• Small and medium size business support for apprentices and trainees. A business with less than 20 full-time employees can apply for wages subsidies of 50% of the apprentices or trainees wage for up to 9 months from 1 January 2020 to 30 September 2020 (up to a maximum of $21,000 per eligible apprentice or trainee).
• -One-off $750 cash payment to pensioners, social security, veteran and other income support recipients and eligible concession card holders including Newstart recipients. Cost $4.8bn
• Regional and community support fund valued at $1bn to those sectors, regions and communities that have been disproportionately affected by the economic impacts of the coronavirus, including those heavily reliant on industries such as tourism, agriculture and education.
• ATO administration relief to those affected by the Coronavirus outbreak, on a case-by-case basis.  

Moody’s responded to the package, stating it is unlikely to threaten Australia’s credit rating, noting “Given the temporary nature of the stimulus package and Australia’s solid fiscal position, the government’s response, which is equivalent to 0.9 percent of annual GDP, is unlikely to have an impact on Australia’s credit outlook."

Australian bond curve moved down in yield, reflecting a flight to safety from equities and risk assets into bonds and cash. At COB 5 March 2020, with the AUD bouncing to US$0.6620 was, the curve was:

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