My name is Kyongsoo Noh, and I am a portfolio manager in our ultrashort duration business here at JPMorgan. Welcome to the 2020 Q3 GTM call for Global Liquidity investors. I hope everyone is as safe and healthy as they can be given the environment. Over the next 10 minutes or so, I’ll be going over a handful of slides that we think are most relevant for front-end fixed income investors.
From a bird’s eye view, the US economy experienced a sharp downturn in Q2 but we are seeing some signs of improvement looking forward into Q3. Having said that, the road to recovery from the pandemic will not be without bumps, and we probably won’t return to full economic normalcy until we get a vaccine.
Conversely, even though the economy isn’t back to full potential yet, thanks to decisive actions by the Federal Reserve, market conditions for liquidity investors are back to business as usual. But with stabilization, has come falling yields; the key question is what to do next in the liquidity investment space.
We begin on p. 20 – where we have 2 charts on the pandemic
We see on the right that while any death is a tremendous loss, the pace of fatalities has improved from the April peak -
This improvement is due to a couple of things: first the more susceptible portions of the population (specifically, the elderly or people with pre-existing conditions) are more aware of the virus now, and they are doing things to protect themselves and second although there is no silver bullet cure at this point, doctors have learned how to better use antivirals like remdesivir, anticoagulants, and anti-inflammatories like dexamethasone to treat the disease with more favorable outcomes
On the other hand, there is some bad news and it is two fold:
(1) I just talked about the improvement in fatalities from April to now, but we are likely to see an uptick in deaths in a few weeks time that are being seeded by the current surge in infections in hotspots across the sun belt, the question is what steps state and local governments will take to bend the curve back downwards
(2) You can infer from the left chart that we are far from herd immunity, which is what we need to get back to normal life
We get to herd immunity when 60% of a population has some form of resistance either from naturally developed antibodies and/or a vaccine; for the US the magic number is 195mm (which is 60% of the 325mm people that live here)
Medical experts say that the true fatality rate is between 0.5% and 1.5%. So if there have been around 120k fatalities so far (the smaller bar on the left chart), it implies that the true infection rate is on the order of 8 to 24mm (this is the potential number of people with some degree of natural immunity)
This implied range of 8 to 24mm is higher than the confirmed infections number of about 2mm (which is the left bar on the left chart), but it’s still well short of the 195mm needed for herd immunity
Turning to p. 21 – this is a chart of the year on year changes of various indicators of economic activity – until we get herd immunity some activities are just not going to see a full recovery from an economic standpoint
Over the past few weeks, we have reopened the economy with mixed success
Some activities such as mortgage applications and driving are starting to get back to pre-virus levels, they are back to positive year on year growth
However, without herd immunity, other portions of the economy will still remain depressed
As you can see by the activity levels in flights and hotels, travel and lodging have been particularly hard hit, and that probably won’t change for some time
Turning to p. 18, this is a bubble chart of economic downturns in the US over a historical timeline; the bubble sizes correspond to the magnitude of the downturn; the y-axis shows the length of the downturn
It’s not on this chart, but I will tell you that consumer spending in the sectors more vulnerable to the virus (namely hotels, transportation, entertainment, restaurants & bars, and retail ex food & beverage) make up about 19% of US GDP
So it’s not a surprise, that the economy is expected to shrink by 13% from peak to trough in Q1 and Q2 of this year due to the shutdowns (just to be clear, we’ll get the official Q2 GDP number on July 30th so the 13% is just a projection for now)
This downturn is painful, and it is deep; in fact, it is projected to be in the top 3 economic downturns in the US in the last century, the other 2 being the Great Depression and the period after World War II)
Fortunately, to help fill the economic gap until we get a vaccine, the government has implemented massive fiscal and monetary stimulus to help support the country
Turning to p. 25, on the left, we have a the summary of the CARES Act (2020), this was the government’s fiscal response to the pandemic; it is sized at $2.4tr or about 12% of GDP (if you recall, that is roughly the same magnitude as the projected 13% downturn on the prior page)
Despite its massive size, this fiscal package will not completely cushion the blow of the downturn; not everyone that needs help is getting it, and it is taking time for aid to fully work its way through the economy; however, without it, conditions today would be far worse
Now what is the shape of the recovery? It’s not on this page, but JPMorgan strategists are calling for a -35% downturn in Q2 GDP and a +20% bounce in Q3 GDP
A couple things about these two numbers (1) it shows a substantial recovery, but not a full V shape and (2) just to avoid some confusion, the -35% and +20% growth rates are quarterly annualized numbers – that’s the typical way GDP growth is quoted; to convert these numbers to the scale on the prior page’s bubble chart, you need to divide by 4
The CARES Act should be enough to prevent a second Great Depression, and without it, we wouldn’t be calling for a sizable bounce in Q3 GDP growth, but again, to open all parts of the economy and get back to normal life, we will need a broadly distributed vaccine, which probably won’t happen until 2021
Turning to p. 32, I will open here by saying that unlike the broader economy which is still far from normal, liquidity conditions in the front end of the fixed income market are already back to business as usual thanks to the Fed’s implementation of a number of monetary stimulus policies
Two measures in particular are still directly working on the front end of the curve, and they deserve investor attention;
First is zero interest rate policy or ZIRP (Z-I-R-P), which you can see on this page
We do expect generic government money market funds to have near zero net yields by late this summer
We also expect generic prime money market funds yields to decline as a result of ZIRP, but we believe that there will be a positive spread of about 10-15 bps between generic prime and generic govie yields when govie yields hit their floor
Second (which is not on this page, but nonetheless significant), the Fed is buying corporate bonds and shares of ETFs that contain corporate bonds in order to narrow spreads and promote liquidity in the corporate debt markets – ZIRP does not work in the economy unless spreads are narrow too.
These purchases are driving up prices of high quality front end credit products, which are precisely the kinds of investments that many short term fixed income investors focus on.
As a result we should continue to see strong market sponsorship of the front end corporate bond space. Technicals are very robust in this market segment, and it is still not too late for investors to capitalize on this.
Before, we end here, I’ll summarize; while we do expect a substantial bounce in Q3 GDP growth from Q2, we do not expect a full US economic recovery until after we get a vaccine.
To bridge the gap between the pandemic and a vaccine, the federal government has implemented large scale fiscal and monetary stimulus programs
Unlike the broader economy which still has some heavy lifting to do in the recovery process, the front end fixed income capital markets have already largely normalized. This is thanks to the swift action by the Fed on the monetary side
Two monetary policies by the Fed in particular are still driving yields for liquidity investors right now. We expect Zero Interest Rate Policy or ZIRP to push yields in the govie money market arena to near zero by the end of the summer; at the same time, various credit buying programs by the Fed are compressing spreads.
With ZIRP in mind, if higher returns are an objective, we have a number of credit strategies with modest to low risk that liquidity clients can implement right now
If you are interested in learning more about these credit strategies, then please reach out to your JPMorgan Asset Management representative, and we’ll be happy to share our solutions and thoughts
Thank you for listening and we look forward to talking with you.
Hi, this is Adam Ackermann, thank you for joining our conversation today.
In the 4th Quarter of 2019, The Federal Reserve Bank introduced several temporary and permanent solutions to address significant and unexpected volatility in key US funding markets. The tools introduced were intended to calm market stress caused by falling levels of excess reserves. The Federal Reserve’s actions were also meant to preserve the integrity of The Central Bank’s target floor and ceiling rates that define its monetary policy rate corridor structure. Collectively, these measures injected large amounts of cash into the system and established the Federal Reserve Bank as a meaningful provider of liquidity to markets. Rates on funding products such as dealer tri-party repo, overnight Time Deposits and Fed Funds reacted gradually and eventually settled into trading ranges that were within a few basis points of benchmark interest rates. Each operation has been conducted by the Open Market Operations desk at the NY Federal Reserve Bank. They are:
Temporary Reverse Repo Operations:
1. Overnight Repo
a. Occur daily each morning
b. Allow Primary Dealers to access cash on a daily basis
c. Stabilize daily funding market stress
2. Term Repo
a. Occur multiple times per week
b. Allow Primary Dealers to lock up cash over longer periods of time
c. Available terms are greater than 7-days
d. Stabilize funding market stress over key regulatory periods like month-end, quarter-end and year-end
3. Direct Security Purchases
a. Ongoing purchases of US Treasury and Agency MBS securities directly through the market
b. Occur Daily
c. Includes securities of different maturities across the yield curve
d. Promotes liquidity in US Government securities market
e. Allows security holders to monetize their holdings and access cash
Generally speaking, healthy public markets should be able to function without significant Central Bank intervention. This is especially true for the largest, most liquid markets in the world – The US Funding and Government securities markets. While its actions were necessary and critical to ensuring proper functioning of the funding markets, the Federal Reserve Bank’s efforts have never been meant to be fully-permanent. Their communications have consistently indicated that their repo operations would be in place until excess reserves reached more robust levels that were more in-line with natural market demand for liquidity.
In 2020 during its April and June meetings the Federal Open Market Committee discussed and acknowledged “substantial improvements” in USD funding markets as a result of its intentional balance sheet expansion over the course of recent months. Moreover, The Committee noted that excess reserves had reached “ample levels”. Following its June meeting, The Committee instructed the Federal Reserve Bank of NY, through its Open Market Operations desk, to adjust the parameters of its repo operations.
This move by the Federal Reserve was an intentional and important pivot away from its role as a primary provider of liquidity for USD funding markets to a secondary backstop role. Specifically, the minimum bid rate on its repo operations was increased by 5 basis points for both the overnight and term offerings. Also, the timing of the overnight operation was shifted from the morning to the afternoon to reinforce the transition of repo operations as a secondary option for primary dealers to access liquidity.
Why should Money Market investors care about this recent change?
First and foremost, the Federal Reserve has acknowledged that its measures were effective in calming stress in the funding markets and rebuilding reserves to more robust levels that ensure healthy functioning of US capital markets. This should be important to and comforting for any market participant
Second, in an environment where liquidity levels are elevated due to an abundant amount of cash in the financial system and rates are close to zero, investors are keenly focused on the income they earn on their most precious commodity – THEIR CASH.
We expect that the adjustments by the Federal Reserve to its repo program will result in marginally higher rates across USD Short-Term Fixed Income complex. Since Primary Dealers will now have to pay an additional 5 basis points to access either overnight and/or term funding from the Fed, they will naturally have less incentive to rely on those facilities as primary sources of cash. Instead, those Primary Dealers will return to standard funding channels such as overnight and term tri-party repo executed with large Money Market Funds and other cash lenders. Additionally, since the Fed’s overnight repo operation will now only be available in the afternoon Primary Dealers will be more inclined to secure their funding needs early in the day through tri-party and Time Deposit markets. Natural cash borrowers such as Primary Dealers will pay market rate for access to stable funding from natural cash lenders like Money Market funds now that the Federal Reserve’s repo operations are a secondary or tertiary source of cash.
The bottom line is that we should expect higher repo and time deposit rates over the near term which should lead to higher rates on products such as US Treasury Bills, US Agency discount notes, commercial paper and certificates of deposit. As short-term fixed rate funding rates drift higher, we also expect to see some spread widening on floating rate notes. This trend should result in slightly higher yields in Money Market funds, ceteris paribus.
Principal stability, one of the main objectives of money market funds, is easily identifiable through the Net Asset Value prints or NAVs. Both Institutional Treasury and Agency Funds and Retail Funds continue to hold Stable NAVs, while Institutional Prime and Municipal Funds NAVs float around 1 dollar, rounded to the 4th decimal place.
Since the inception of Floating NAVs or FNAVs, movements have generally been incremental and slow; if Overtime, we’ve seen the FNAVs of institutional prime funds deviate a few bps on either side of a dollar, but we ultimately view the natural state of Institutional Prime funds FNAV’s to reside +/- 1 bp on either side of 1 dollar given the short duration profile and general low price volatility of the underlying assets.
Over the last few months, due to increased market volatility related to COVID-19 and Fed related moves, the industry has seen peak to trough movements exceeding almost 30bps in some funds. At the height of the volatility, the industry saw FNAVs in the low .9980’s, or about 20bps below the natural state of a dollar NAV. With Prime FNAVs elevated leading into the shutdown, in some cases above 1.0010, the actual decline was larger. It’s important to note that not all funds printed FNAVs in the 80’s, and not only did industry FNAVs quickly return to their natural state, but they have since rallied back above 1.0010 or 10 bps above a dollar, in some instances.
So, if historically FNAV movements have been incremental and slow, what drove this volatility?
During March, the Fed reduced rates 150bps to the lower bound of 0-25bps in response to the COVID-19 outbreak. At the same time, redemptions were occurring in the prime money market space. Remember-this was a liquidity driven event and was unrelated to specific credit concerns. Institutions wanted to ensure they had enough cash to weather the shutdown. With this in mind, and with a focus on liquidity, prime money markets were not adding to term positions. However, because certain institutions still required term funding, term money market levels increased. As yields widened relative to that of like securities held in money market portfolios, FNAVs began to fall, reaching their nadir around mid-March.
The Fed soon intervened with multiple facilities as a means to inject liquidity into the market. One program, the money market mutual fund liquidity facility or MMLF, had the largest impact on the prime money market space. This facility allowed banks or dealers to purchase U.S. Issued CP and CDs of highly rated issuers, and Tsys and GSE securities from 2a-7 funds, which they could then pledge as collateral to the fed for a non-recourse loan, or one that does not have any balance sheet implications.
Once the fed intervened, liquidity quickly returned to the market, assets began to flow back into the prime money market space, and prime money markets funds began to once again buy term securities out the curve. The effect on the portfolio FNAVs was twofold. As demand increased, yields decreased, which helped raise the funds FNAVs from their lows. Ultimately, as yields narrowed relative to like securities held in portfolios, the pricing of those positions increased, and helped to raise the FNAV of the fund. Additionally, as funds added term securities and yields continued to decline, those newly added positions were then quickly priced higher, resulting in an immediate upward impact on the FNAV of the underlying fund.
In the end, general market volatility did lead to some short-term relative volatility in the FNAVs of prime money market funds. However, FNAVs quickly returned to pre-shutdown levels. Overtime, as higher legacy positions roll off of portfolios and are reinvested closer to market levels, we anticipate Fund FNAVs to return to their natural state of a bp on either side of a dollar, thus continuing to realize one of their main objectives of principal stability.
Hi, this is James McNerny, from our ultra-short, Managed Reserves team. I want to start by wishing you and your loved ones well as we all continue to battle through this health crisis together.
It’s July and we finally made it through a very long second quarter and first half of the year. After experiencing some of the worst volatility and illiquidity we’ve ever seen during the month of March, the front end of the curve has done an almost complete 180 with an incredible improvement in tone throughout the quarter, leading to a largely directional trade towards lower yields and strong performance.
To put those moves into context, let’s quickly refresh where we were earlier in the year. In February, valuations were relatively rich as corporate spreads in the ultra-short space were at-or-near all-time tights of around 30 basis points over matched-maturity Treasuries. In March, following the initiation of the Saudi/Russia oil price war, and with the proliferation of COVID-19 from Asia to Europe and then into the US, liquidity and confidence in credit markets began to dry up and spreads widened substantially. By March 20th liquidity had all but evaporated and spreads had widened to almost 450 basis points over Treasuries. But this was not just an ultra-short issue……we saw stress in credit markets up and down the curve, from very short credit money market funds to long bonds. In fact, it wasn’t just a credit issue. We saw stress in the US Treasury market, with bid/ask spreads trading much wider than normal.
To their credit, the Federal Reserve recognized how broken the market was and on Monday, March 23rd they announced extensive new measures to support the economy, including the Primary and Secondary Market Corporate Credit Facilities. From that point onward we’ve seen credit spreads retrace the majority of the March widening, ending the second quarter at approximately 70 basis points over. That indicates to us the Fed has been largely successful in restoring confidence and liquidity to the market, and we believe that with their support now firmly in place, we should not see a return to the illiquidity witnessed in March.
In front end flows, we saw over $1 Trillion dollars make its way into U.S. money market funds in March and April. With the Fed keeping overnight rates at the near-zero bound, that means there is a lot of money now on the sidelines earning yields very close to zero. Because of that, and the confidence returned to the ultra-short and short-term credit markets, we’ve seen investors returning to the ultra-short space, willing to move modestly out the curve in search of yield. In April and May we saw over $10B in retail inflows into U.S. ultra-short funds, and we anticipate that number to be higher when the final quarterly metrics are announced. We also expect that trend to continue given our low-for-long outlook on rates, lending further technical support to risk asset valuations in the ultra-short space.
Anecdotally, since March our ultra-short platform has seen over $5B in customer inflows globally.
The support of short-term investment grade credit market has informed our investment thesis, and since the announcement of the corporate facilities mentioned earlier, our approach has been to not fight the Fed, choosing to add to, and extend our investment grade corporate exposures aggressively. While we are cautious on the economic outlook in the coming quarters and the implications for credit fundamentals given the unknowns posed by the pandemic, we want to participate in this rally on the back of the strong technical demand already discussed. And again, that demand is not only coming from the participation of the Fed, but importantly from flows back into the space as investors are identifying it as a place for strong relative yields and performance especially vs the near zero rates of money market funds. But with some sectors and names under stress given the macroeconomic realities of COVID-19, active management of the credits in the portfolio is paramount and there are definitely names and sectors we have reduced or are avoiding altogether. For example, certain subsectors of the energy market, consumer cyclicals and consumer related asset backed securities. Instead we are focusing primarily on a portfolio tilted towards investment grade, high quality corporate credit in names with strong balance sheets and fundamentals that will likely continue to benefit as more money flows into the space from both investors and the Fed.
Should you have questions or wish to speak, please do not hesitate to contact your J.P. Morgan Asset Management representative who would be happy to put you in touch with us. In the meantime, thank you for joining the conversation, please take care of yourselves and stay healthy and safe.