Liontrust GF High Yield Bond Fund is manufactured by Liontrust Fund Partners LLP and represented in Malta by MeDirect Bank (Malta) plc.
By Phil Milburn, Liontrust Global Fixed Income Team
While I can claim no expertise in infectious viral pandemics, I can hopefully offer a couple of insights into the economic part of the Coronavirus situation. After dramatic falls in risk markets, comparisons are being made with the 2007-09 credit crisis but, economically, this crisis is nowhere near as bad. So why do I say this?
An existential crisis for the financial system? No
Put simply, the whole system almost collapsed in 2007/08; the world was a matter of days away from paper money being almost worthless and if that money was stored in a bank account, it would have disappeared.
Coronavirus will cause a global recession; for the pedants who use the technical definition, which is two negative quarters, Q1 might scrape into positive territory due to the delayed impact of the virus but the run rate is recession. We believe the correct reaction is to worry about the depth and length of this recession, but unless it becomes a multi-year event, the system will survive. Do bear in mind that the global economy was in good shape coming into this crisis with an upswing starting post 2019’s trade wars.
Accessing liquidity more important than the price
Central banks around the world have been cutting interest rates to help mitigate the worst of the economic impact. In my opinion, these cuts pale into insignificance compared to the liquidity measures being provided: the Federal Reserve announced a $1.5trillion package on 12 March for example. The key here is accessing money, not the price of money.
In 2007/08, when liquidity dried up, large corporates drew down on their committed, previously undrawn, bank facilities; in this cycle, the banks have far less exposure to this sudden balance sheet expansion. Crucially, the central banks are providing liquidity lines to enable the financial system to comfortably fund these needs.
As an aside, a few large companies, and those owned by private equity, are already drawing down credit lines, thinking they have a first-mover advantage; this is analogous to someone buying all the hand sanitisers from the supermarket and also entirely self-defeating. If you drain all the liquidity, then you hurt your customers and suppliers; if you buy all the hand sanitisers, other people are more likely to catch the virus and pass it on to you.
For smaller companies, the need to access money is even greater as the temporary shutdowns create a major drag on working capital as well as profitability. This is where programs such as the Bank of England’s TFSME (term funding for SMEs) come in to play. There is a mismatch as it is not term funding that most small companies will need, rather a drawing on their revolving credit facilities (basically like an overdraft facility) for a few quarters. The banks’ treasury departments can easily manage this.
Another way of freeing up banks’ lending capacity is to reduce capital needs; the Bank of England has removed the counter cyclical buffer and the European Central Bank has relaxed capital rules.
The liquidity injections from central banks are all about managing the supply side of the equation and designed to help the real economy by providing huge funding through the financial system as an intermediary. So, what about the demand side of things?
Keeping the consumer solvent
Included in the financial system measures are policies to encourage loan forbearance, this includes corporate lending and household mortgage servicing. These vary by jurisdiction with Italy being a leader for obvious reasons. The point here is to avoid creating corporate insolvencies, rising unemployment and homelessness during what should be a temporary disruption to activity.
The fiscal side of the equation is also essential here, providing sick pay, subsidising temporary reduced hours or covering wages if possible. Labour markets were tight going into this crisis so one should envisage that most companies will do their best to hold onto staff, albeit with some on reduced pay.
The most economically vulnerable are the self-employed and gig sector workers, for whom a financial safety net during the virus would be a massive boon. Overall, provided employment remains solid then the consumer will stay strong and this sets us up well for a decent growth rebound in H2.
Other fiscal packages are also being worked on. The US is likely to pass its act through congress later today. Germany is now actively talking about temporarily sacrificing their budgetary “black line” and I would expect an announcement next week.
Minding the temporary gap
In conclusion, there already have been a lot of policy responses to help mitigate the economic damage caused by Coronavirus. The financial system will comfortably remain solvent. Given the amount of monetary and fiscal stimulus, if the virus impact peaks in Q2, then the second half of the year should see a significant growth boon.
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