InvestNow News – 27th Mar – Legg Mason – Coronavirus Pandemic: Difficult Tradeoffs

Events surrounding the pandemic continue to evolve fast and furious. Yesterday morning, on March 23, the Federal Reserve (Fed) announced a range of new actions, dramatic in terms of both initiative and scale. However, the nature of the economic crisis would suggest a lot more will come before this is over.

Events surrounding the pandemic continue to evolve fast and furious. Yesterday morning, on March 23, the Federal Reserve (Fed) announced a range of new actions, dramatic in terms of both initiative and scale. However, the nature of the economic crisis would suggest a lot more will come before this is over.

The Treasury Market

The Fed was forced to move aggressively. Treasury yields had been rising since March 9 until the 23rd, which made no sense in view of the collapse in economic activity taking place. The rise in nominal yields coincided with retreating breakeven inflation rates—10-year Treasury Inflation Protected Securities (TIPS) spiked by about 100 basis points (bps) from their low on March 9, while the dollar surged, and gold tumbled. Some tied the phenomena to an unwind of risk parity trades. Others worried about the scale of debt issuance accompanying the massive fiscal support being organised for the economy. Neither was the real reason.

Forced liquidation in order to raise dollar cash was the most likely cause of the back up in long bond yields. The speed of the deterioration in financial conditions has been outpacing the Fed’s response to the crisis. That may have started to change yesterday: the yield on 10-year TIPS is down about 60 bps from last Thursday’s peak, breakeven inflation rates are rising, the dollar is off, and gold has rallied. Real yields need to stay down and move lower because market conditions are still not very liquid.

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