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The Economy and the Markets | First quarter 2020

  • The economy is facing what might turn out to be the worst downturn since shortly after WWII, but the Federal Reserve and government are using all policy levers to soften the blow.
  • This is a multi-pronged challenge – a correction in valuations, a liquidity squeeze, a collapse in energy prices, and an upturn in defaults stemming from high corporate leverage and COVID-specific shocks.
  • Uncertainty is exceptionally high, placing a premium on a strong framework for assessing new information. 

Risk off!

Last quarter, we wondered whether the market had gotten ahead of itself.  While we knew that good times were destined to end, we couldn’t identify the catalyst.  It’s now clear that the COVID-19 pandemic will end the record U.S. economic expansion.  Draconian public health measures focused on social distancing are bringing the economy to a standstill.  The U.S. is not alone, and we are entering a synchronized, global downturn.  The decline looks big, uncertain, and skewed to the downside, prompting an epic policy response.  Investors were positioned for a more conventional end to the extended business cycle with corporate credit suffering the most.  Outside of particularly vulnerable industries (travel, for example), the pandemic is especially daunting for the consumer and certain areas within commercial real estate, most notably retail and hotels.  This adds new fears about two segments that looked well positioned at the beginning of the year.  Given the severity of the economic disruption, few sectors are immune to the impacts of COVID-19 with large portions of the global economy (individuals and corporate borrowers) requiring additional liquidity to bridge the gap.

The resulting inability to box in the potential economic downside drove extreme market volatility in the quarter.  The Dow experienced its second biggest daily drop ever in mid-March.  The 20-day moving average of the Volatility Index (VIX) reached 60, rivaling the volatility we saw in 2008 at the height of the global financial crisis (the GFC).   After stellar performance through mid-February, almost all markets except government bonds declined precipitously.  Stocks were down 20-35% for the quarter, commodities fell almost 35%, and credit was hit especially hard.  High grade credit spreads rose by 179 basis points (bps), peaking at +373bps before rallying back to +272bps at quarter end.  Investment grade bonds produced excess returns of -13.50%, easily the worst quarterly result on record.  The spread on the high-yield index ended the quarter at 880bps, up 544bps, to yield 9.44%.  The treasury market went on a wild ride, with the 10-year treasury yield falling from 1.92% at year-end to only 0.67% at the end of the quarter.  At times, treasury bills have been bid to negative yields. 


Q1 cboe volatility index

Source: Bloomberg. Date as of 4/02/2020. Data spans from 7/02/2007 - 4/02/2020.

The inability to box in the potential economic downside drove extreme market volatility in the quarter.


Policymakers recognize that this is a multi-pronged challenge – a correction in valuations, a liquidity squeeze, a collapse in energy prices, and an upturn  in defaults stemming from cyclically high corporate leverage and COVID-specific shocks. The policy response exceeds the actions taken during the GFC. Programs are focused on maintaining market liquidity and softening the economic downturn, with particular emphasis on those hurt most by the pandemic.

The Federal Reserve (the Fed) pulled all stops. Policymakers cut the federal funds target by 50bps in early March and then, in a 100bps move, all the way to 0% on March 15. It then resurrected many of the programs from the GFC, including a new, unlimited QE program focused on treasuries and mortgage-backed securities, short-term funding support (TOMOs1, CPFF2, TALF3 for repurchase agreements, commercial paper, and asset-backed securities), easier terms for banks and dealers (discount window terms and the PDCF4), and dollar liquidity for foreign central banks (dollar swap liens and FIMA Repo5 facility). Recognizing that dealers have limited balance sheet capacity, they developed new facilities to fund the purchase of investment-grade corporate bonds in both the Primary-and Secondary-Market Corporate Credit Facilities (PMCCF and SMCCF).

Congress is doing its part, too. After passing legislation to fund COVID vaccine research ($8bb) and increased state aid ($104bb), it passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This act provides an unprecedented $2tr of support, targeting hard hit segments of the economy. It includes direct support for consumers and small businesses ($1.2tr), $500bb of first loss capital and direct lending to affected industries (including airlines), health care funding, and increased unemployment benefits (including broadened access).



q1 cboe federal reserve balance sheet

Source: Bloomberg. Date as of 4/02/2020. Data spans from 7/02/2007 - 4/02/2020.

Mulit pronged challenge - A correction in valuations, a liquidity squeeze, a collapse in energy prices


At this time, investors don’t have enough information to accurately estimate the length and severity of the pandemic response. The longer economic growth is constrained by social distancing, the deeper and more long lasting the impact. Households and small businesses entered this crisis with limited reserves, increasing the risk of breaching a tipping point that accelerates the downturn. The effectiveness of the policy response is a key question and will be an important factor this downturn. Our view is that the Fed has the necessary tools to improve market liquidity, and that liquidity concerns should dissipate for high quality borrowers. Monetary policy is likely to have a limited effect. Lower rates may eventually work their way into borrowers’ pockets, but they’re unlikely to stimulate demand during a lock down. On the other hand, no one really knows how effective the CARES Act will be though $2tr represents an impressive 9.5% of GDP. The act appears to do a good job of targeting shocked segments such as small businesses and households, but no one really knows how soon or how efficiently the money will reach its targets.

Donald Rumsfeld, the former Secretary of Defense, pointed out the importance of recognizing that known risks are only part of the story. He also worried about “unknown unknowns” those risks that we don’t realize we should be assessing. We’ve expressed concern that the policy toolkit will be stressed in the next downturn, bringing us into uncharted territory. The Fed has used the dry powder in its conventional toolkit, and policy innovation may raise new concerns that aren’t yet understood. Already implemented innovations such as the PMCCF and SMCCF stretch the limit of the Fed’s mandate and put the institution at risk to corporate defaults or unintended market distortions. Money printing is in, and the federal deficit is poised to explode. The market is pricing in lower-for-longer inflation and rates, but deglobalization and money printing may disrupt the current paradigm. In short, uncertainty is off the charts, and high volatility is likely to persist until the path of the downturn is more certain and these concerns are clarified.

1.   Temporary open market operations (TOMO)

2.   Commercial paper funding (CPF)

3.   Term Asset-Backed Loan Facility (TALF)

4.   Primary dealer credit facility (PDCF)

5.   Foreign and Internal Monetary Authorities (FIMA)

Source is Bloomberg for all information, unless noted otherwise.

Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. This commentary should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. Investors should keep in mind that markets are volatile and unpredictable. Past performance is no guarantee of future results. Opinions expressed herein are those of Securian Asset Management, Inc., only. The Economy and the Markets has been prepared for informational purposes only and is the opinion of Securian Asset Management, Inc., a registered investment advisor.

Securian Asset Management, Inc., is a subsidiary of Securian Financial Group, Inc.

For Institutional Investment Use Only

F60311 Rev 4-2020 DOFU 4-2020