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Governments and central banks around the globe have been spending unprecedented
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amounts 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. Good afternoon, Jasons,
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thank you for joining me.
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Good afternoon, Jen. Thanks for having us.
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Good to have you. Now,
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I wanted to start off with taking a look at the difference between the Fed and
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the Bank of Canada's response to the pandemic. JD,
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could you tell us a little about the emergency interest rate cuts and massive
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financial stimulus package backed by the governments and central banks?
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Yeah, so as you said, it's been very strong response by the central banks,
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both in Canada and the U.S. When we look at monetary policy,
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there's typically three levers 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 U.S. Fed
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cut the overnight rates from 1.75% down to
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0.25% (25 basis points) in the month of March. So,
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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, which has been pretty significant,
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is open market operations. So,
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this is the buying and selling of treasuries or government securities and other
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securities to put money into the financial markets. So,
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we saw them really ramp up starting in March.
So,
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the U.S. securities held by the U.S. Federal Reserve climbed from
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4 trillion to over 6 trillion in a matter of three months.
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And in Canada,
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the Bank of Canada's balance sheet grew from 110 or 120 billion to
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500 billion. So,
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significant increases in throwing a lot of money into the financial system to
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support it during the lockdowns.
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And one thing that was interesting that we haven't seen the central banks do as
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much was to take the ECB approach of "whatever it takes" and
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really ramp up buying of
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NHA MBS securities in Canada, and also corporate bonds. So,
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the U.S. Fed is buying both ETFs and, surprising to us at Canso,
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fallen angels: so,
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corporate bonds that were issued as investment grade that have been downgraded
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because of COVID-19 to high-yield issuers. So,
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this is something that we haven't seen previously and has had a big effect on
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the markets.
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And let's focus on how this has impacted trading in the credit markets. JB,
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as head of Canso's trading desk,
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could you tell us a little about what you've seen over the past few months?
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Absolutely, Jen. So,
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what we experienced before the central bank measures came into place was
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complete panic. There was tons of selling,
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spreads were going wider, and liquidity was evaporating.
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And so in the early stages of this,
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there was a point where Canso was well-positioned with liquid portfolios and we
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needed to sell NHA MBS in covered bonds.
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And a day in the market there was one bank that would not bid on their own
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covered bond. 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 and could not get a bid.
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That was the height of illiquidity that we experienced.
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But once the central bank started stepping in with their measures,
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all of a sudden, liquidity started to return, spreads began to tighten.
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And if you look at the U.S. as an example,
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corporations flooded the market with new issues,
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and there was demand.
400 billion of new issues were done in the month of
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April, and over 400 billion was done in the month of May.
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You compare that to the prior two years,
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the same months were only approximately 200 billion was what was done.
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So there was a twofold increase in new issuance volumes at a time when you had a
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pandemic going on.
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That just illustrates how powerful the impact was that central banks had with
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their measures. One other interesting anecdote that I would like to share,
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JD alluded to the Federal Reserve coming in and deciding to go ahead and
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buy BB-rated securities fallen angels. Well,
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they picked an arbitrary date for when you became a fallen
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angel,
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and what that meant was that any company that was downgraded before March 22nd
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was not eligible to be purchased. And for us,
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we had that opportunity to go ahead and buy some of those bonds. As an example,
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Kraft Heinz is a bond that we hold in our portfolios.
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It had got downgraded in February; therefore,
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we were able to buy August 22 maturity bonds at $89,
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which were recently tendered at $98.75,
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an approximate 11% return a month. And so,
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the pandemic brought opportunities,
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and the central bank measures created additional opportunities,
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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. And that's it from me. For more information,
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go to the Canso Funds website and read the June Corporate Bond Newsletter.