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Governments and Central Banks around the globe
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have been spending unprecedented amounts
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in response to the COVID-19 pandemic.
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And the effect on the financial market has been extreme.
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To speak a little more about that
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I'm joined by Jason Davis, JD and Jason Bell, JB
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both Portfolio Managers at Canso Investment Counsel.
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Good afternoon Jasons thank you for joining me.
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Good afternoon Jen, thanks for having us.
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Good to have you.
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Now I wanted to start off with taking a look
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at the difference between the Fed
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and the Bank of Canada's response to the pandemic.
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JD, could you tell us a little about
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the emergency interest rate cuts
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and massive financial stimulus package
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backed by the governments and central banks?
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Yes so as you said, it's been a very strong response
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by the central banks, both in Canada and the US.
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When we look at monetary policy,
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there's typically three leavers
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that central bankers pull on.
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You have the discount window or the overnight rate,
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reserve requirements at banks and open market operations.
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So we saw both the Bank of Canada and the US Fed
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cut the overnight rates from 1.75% down to 0.25
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25 basis points in the month of March.
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So a significant cut and that happened quickly
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and likely as their lower bounds, both central banks have
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talked about not wanting to go to negative rates.
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And then another lever they pulled on
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which has been pretty significant is open market operations.
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So this is the buying and selling
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of treasuries or government securities and other securities
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to put money into the financial markets.
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So we saw them really ramp up starting in March,
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so the US..
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securities held by The US Federal Reserve
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climbed from four trillion to over six trillion
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in a matter of three months.
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And in Canada, the Bank of Canada's balance sheet grew
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from 110 or 120 billion to 500 billion.
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So significant increases and throwing a lot of
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money into the financial system to support it
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during the lockdowns.
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And one thing that was interesting that we haven't seen
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the central banks do as much was to take the ECB approach
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of whatever it takes and really ramp up buying of
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NHA MBS securities in Canada and also corporate bonds.
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So the US Fed is buying both ETFs
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and surprising to us at Canso fallen angels.
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So corporate bonds that were issued as investment grade
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that have been downgraded because of COVID-19
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to high yield issuers.
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So this is something that we haven't seen previously
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and has had a big effect on the market.
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And let's focus on how this has
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impacted trading in the credit markets.
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JB as head of Canso's trading desk,
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could you tell us a little about
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what you've seen over the past few months?
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Absolutely Jen.
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So what we experienced before the central bank measures
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came into place was complete panic.
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There was tonnes of selling, spreads were going wider
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and liquidity was evaporating.
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And so in the early stages of this, there was a point where
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Canso was well-positioned with liquid portfolios
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and we needed to sell NHA MBS and covered bonds.
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And a day in the market there was
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one bank that would not bid on their own covered bond.
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To give a sense of what that means
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you're talking about a AAA bond
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that a promise to pay from a tier one charter bank
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that's backed by a pool of assets we could not get a bid.
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That was the height of the liquidity that we experienced.
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But once the Central Bank
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started stepping in with their measures,
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all of a sudden liquidity started to return,
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spreads began to tighten.
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And if you look at the US as an example
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corporations flooded the market with new issues
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and there was demand.
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400 billion of new issues were done in the month of April
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and over 400 billion was done in the month of May
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you compare that to the prior two years the same months
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were only approximately 200 billion was what was done.
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So there was a two-fold increase in new issuance volumes
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at a time when you had a pandemic going on,
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that just illustrates how powerful the impact was
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that central banks had with their measures.
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One other interesting anecdote that I would like to share
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JD alluded to the Federal Reserve coming in
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and deciding to go ahead and buy
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BB rated securities, fallen angels.
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Well, they picked an arbitrary date
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for when you became a fallen angel.
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And what that meant was that
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any company that was downgraded before March 22nd
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was not eligible to be purchased.
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And for us, we had that opportunity to go ahead
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and buy some of those bonds.
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As an example Kraft Heinz,
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is a bond that we hold in our portfolios.
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It had got downgraded in February and therefore
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we were able to buy August 22 maturity bonds at $89,
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which were recently tender at $98.75,
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an approximate 11% return a month.
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And so the pandemic brought opportunities
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and the central bank measures
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created additional opportunities, but we had to act quickly
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And that's how we reacted during the last few months.
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Well, thanks for that info Jason
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and that's it from me.
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For more information go to the Canso Funds website
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and read the June Corporate Bond Newsletter.