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The phoney war in markets

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Patrick Kelliher

In my previous blog [1], I warned of a looming crisis in corporate bond markets as a result of the Covid-19 pandemic and intrinsic weaknesses in corporate bond fund liquidity. Sure enough, US investment grade corporate bond spreads rose from just over 100bps in mid-February to a peak of 401bps on the 23rd March [2] as the Covid-19 pandemic took hold in Europe and the US. With liquidity in the market evaporating, corporate bond ETFs started to trade at a discount to NAV [3].

This was linked with a wider market rout with both the S&P500 and FTSE100 falling by 1/3rd in the month to 23rd March. As investors fled to safety, 10-year yields on US Treasury Bonds fell from ca.1.6% p.a. to just over 0.5% p.a. by early March [4] with short-term Treasury bills even going negative for a short while [5]. Worryingly for the UK, long standing concerns over its reliance on overseas investors and the impact of Brexit lead to the pound collapsing from £1:US$1.31 to £1:US$1.15 [6]...

Corporate Bonds - the calm before the storm?

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Patrick Kelliher

With the falls in equity markets over the past week, there has been a modest uptick in corporate bond spreads with US investment grade spreads up ca.20bps to 120bps or so. However, these are still at the lower end of recent history, with US investment grade spreads frequently trading over 150bps in the last 10 years and reaching over 300bps in the aftermath of the Lehmans default. I think the markets are not properly pricing in the risks associated with Corporate Bonds, and there is a risk of a collapse of this market on a par with the aftermath of Lehmans.

Even before the onset of Covid-19, the IMF was warning of the risks posed by rising corporate burdens and potential issues with corporate bond illiquidity in its 2019 Global Financial Stability Report [1]. On the former, the IMF estimated that in a mild slowdown, about half as severe as that suffered during the Global Financial Crisis of 2007/09, debt owed by firms unable to service the interest could...

Geopolitical Risk – a question of when rather than if?

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Patrick Kelliher

Living in the UK, it’s easy to get wound up in the chaos of Brexit, but the possibility of a hard Brexit is just one of many geopolitical risks faced just now. Broadly heading east to west:

Spain – while things seem to have gone quiet in Catalonia, the fact remains that a greater proportionate of its electorate voted for independence than the proportion of the UK electorate voted for Brexit, even though opponents boycotted the vote [1]. The prosecution of Catalan politicians behind the vote is likely to exacerbate tensions, as will the emergence of the right-wing Vox party vehemently opposed to Catalan self-determination. While the UK faces the prospect of a break up with the possibility of a second referendum on Scottish independence and/or a border poll in Northern Ireland, it is not the only one that faces the threat of secession.

Italy – while Matteo Salvini may have recently been outmanoeuvred out of power, he is...

Looking back at 2017, looking forward to 2018

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Patrick Kelliher

I have been meaning for some time to post a blog on how the risks I called last year matched up with reality. I appreciate it’s a bit late in the day but I would cite work commitments and the fact that events continue to develop. As that old Chinese curse goes, we live in interesting times.

Speaking of China, the first risk I called out was a trade war between China and the US [1]. Thankfully this has not come to fruition, partly because the US needed Chinese help to put pressure on North Korea, but this is still a live issue. There have been American grumbles about sanctions busting by Chinese companies, while attempts to cut Chinese companies with ties to North Korea off from the US dominated global financial systems were only rebuffed by China applying similar pressure to US firms with operations in China. It may be that we are in a “phoney war” phase just now but this could get hot.

As it is, US trade relations with the EU are going through a rocky...

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