Tax Benefits of Charitable Giving
Will government moves end the wild ride?
CIBC Asset Management’s Patrick O’Toole explains the stress on investment grade and high yield credit markets, and where all bond types may go next as we move towards 0% interest rates.
Transcript: Bond Update – Will Government Moves End the Wild Ride?
[Soft music plays]
[Onscreen Title: Bond Update: Will Government Moves End the Wild Ride?]
[Onscreen Text: Patrick O’Toole Vice-President, Global Fixed Income CIBC Asset Management]
Patrick: The Fed's actions today should actually alleviate some of the pressures you've seen in the corporate bond market. And you could see those yields drift a little lower as credit spreads start to move a little tighter, and they gapped in this morning, about a quarter of a percent already in the United States market. There's no doubt there's been a lot of pain in the corporate bond market. They're actually negative on a year-to-date basis, whereas you've got government of Canada bond yields are very positive. And you're seeing the stress is most acute in the high yield area. You saw credit spreads there get as low as 337 (basis points) on January 16. As of Friday, March 20th, they moved to over a thousand basis points just over that line. And you've seen that total return negative 18.7 percent in the broad high yield market, the U.S. So, with these credit spreads I mentioned where we're at 230 (basis points) in investment grade, just over 1,000 in high yield. What's the recent history been?
Well, during the great financial crisis, investment rate spreads hit 360 basis points, high yield hit over 2,100 basis points. And the 2011 Greece crisis and the 2016 episode of declining oil prices got down to 25 bucks. We saw investment grade spreads get to 175 and high yield get to 880 under both of those episodes. So, the reaction so far is much worse than we saw in the 2011, 2016 episodes. But we haven't approached the great financial crisis levels yet. We're on the way there. I just suspect because of the speed of these programs that the central banks are implementing, we're not going to get to that stage, but we'll have to see.
There's no doubt that the fallout for companies is going to be still problematic. Insurance companies, pension funds and more so in particular, will have funding issues or at least matching their liability issues. Energy companies are going to see defaults start to soar. You're going to see M&A (mergers & acquisitions) and bankruptcies will be the story for the energy sector for the next little while. I mean, it's pretty much a lay-up we're getting a recession.
I call it basically like a flash depression. You know, depression is really a prolonged deep recession. This one looks like it might be a very quick depression. I've seen some estimates as high as 20 percent contractions in GDP in the second quarter. Some of the measures that we're all that we're taking now, will bend this curve. It looks like you'll see things snap back at some point later this year. So, as I said earlier, it means a new lower range for yield.
But the good news, I guess, you could take away is that yields are rising on the expectation that things are going to get better from these programs the central banks and the governments are implementing. Yield curve is normalizing, so you have positive slope yield curves in both Canada and the U.S. and that really is a sign that the future is brighter, and that this too shall pass. But I think the fallout really still is that we're likely stuck with new, even lower yields for the foreseeable future than you might have thought 2-3 weeks ago or so.
The Fed is going to be leaving its rate at zero percent for the foreseeable future. That's an attempt, and the other measures they're taking to try and get a V-shaped recovery when things stabilize. And I think that the buyers of the 10-year treasury bonds, which is kind of like the benchmark we look at, a month ago, you would have thought 2.25%, if we back up to that level, you'd see buyers come back in. I think in the world we're in now, it's more like 1.25 to 1.5%. And buyers return to the Treasury bond market.
We've been of the view that the central banks will use every and all tools at their disposal. It's been a mistake to underestimate their ability to come up with new programs as we've seen today. The Fed announcing some new programs to help the corporate sector. And they'll be injecting money in for the businesses, as well, to absorb lost wages for workers. The worry is more so the politicians don't give them the added authorities in time that they might need. But so far so good on that front.
So our advice is don't panic. We've seen these episodes before. Riding it out tends to be the thing to do at these levels that we're seeing on investment grade spreads and high yield corporate bond spreads as well. You're getting probably the second-best levels we've seen in the last 20, 30 years. So, the differences we're seeing this time, I think is really the speed of response from the central banks and the governments. There's going to be more programs coming in all likelihood, but they are really pulling out all the stops.
You know, you're not seeing it just here and in the U.S., but you're seeing it in Europe as well. People learned the lesson from the great financial crisis. If you're going to do this, you have to come in quick, sharp, and you're not going to offset the damage from everybody staying home for who knows how long. You certainly can set the stage for a broad, sharp recovery once things do stabilize. And that I think, going to be the follow from the steps that these central banks and governments are taken and taken so far.
So what should investors do in this time? I think one of the things you want to look is start to deploy some of the cash you might have built up. There's always cash for the rainy day. You'd have to say this is more than just a rainy day. It's more like a big hurricane. A tsunami floods, everything else stacked up at the same time. So it's time to start slowly deploying some of that cash in the fixed income markets. Corporate bonds really are extremely attractive at these times. Now, we've seen, as I said earlier, you haven't seen spreads these this high since the great financial crisis exceeded the last couple of episodes like the 2011 Greece crisis, the 2016 episode where oil prices get down to U$25. We are well above those levels already. These are great entry points if you're buying corporate bonds. You don't have to be in a huge rush, but start to slowly deploy some of that capital.