By Gary Stringer, Kim Escue and Chad Keller, Stringer Asset Management
In addition to the recent equity market downturn due to fears over the spread of COVID-19, we have once again seen stress in the fixed income markets similar to the fall of 2008. Spreads on bonds have widened dramatically due to liquidity issues, and most bond market sectors are experiencing illiquidity or bid levels well below their marked to market prices. This is the result of too much supply as worried investors are basically liquidating even high-quality bonds for cash. In addition, fears associated with the pandemic’s impact on the economy and the impact of tumbling oil prices has called into question the credit worthiness of many energy related bond issuers that make up a large portion of the high yield space. This has created a dislocation as the bond market experiences a period of price discovery.
What began as widening spreads in high yield due to their equity sensitivity and liquidity has reached much further into the almost all bond sectors. Even off the run (secondary market traded) U.S. Treasuries are experiencing wider than normal bid- ask spreads in this environment. This supply and demand imbalance in a world of much lower dealer inventories and growing institutional use of fixed income ETFs has left many with bonds that are at this point illiquid or bid at throw away prices that are not reflective of their value. Adding to the issue, troubles in the commercial paper market, which is a necessary short- term financing source for operating capital for many large corporations, has prompted the U.S. Federal Reserve to once again step up with bond purchases to create liquidity.
Fortunately, the U.S. Federal Reserve has announced plans to purchase an unlimited amount of bonds. In the past, these purchases have been limited to U.S. Treasuries and agency mortgage-backed securities. However, they have for the first time included corporate bonds, municipal bonds, and even fixed income ETFs. This support coupled with the Commercial Paper Funding Facility should help improve liquidity in both the bond market and the short- term funding market. The Fed’s ability to respond more quickly than during the financial crisis, in our opinion, is a positive and should help stabilize the bond and funding markets at a quicker pace than in 2008. Once the excess supply is worked out of the system, we should see liquidity spreads and market valuations normalize.
Whether it is individual high quality corporate and municipal bonds, fixed income mutual funds or ETFs, investors who are able to should consider staying the course through this period of price discovery and allow the Fed support to bolster the bond market.
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