By now I assume you know that today was another brutal day for U.S. stocks (although markets moved up significantly in the last hour.) The Standard & Poor’s 500 closed down another 1.71% and the Dow Jones Industrials dropped 0.98%. The NASDAQ Composite was lower by 1.87% and the Russell 2000 small cap index continued its course of rising less and falling more by closing down 2.00%. Unlike in recent down sessions, emerging market stocks trailed the U.S. indexes with the iShares MSCI Emerging Markets ETF dropping 2.00%.
But as nasty as the day was for U.S. stocks, the session was even more for bond yields. And that retreat in bond yields came with worrying signs of thin trading volumes for credit markets in general.
The yield on the 10-year U.S. Treasury dropped another 14 basis points to 0.78% after hitting a record low of 0.66% during the day. The yield on the 2-year Treasury fell again to 0.51%. The yield on the 10-year Treasury is now down 89 basis points in the last month and 194 basis points (almost 2 percentage points) in the last year. The yield on the 2-year Treasury is down 92 basis points in the last month.
But the biggest problem in the credit markets isn’t plunging yields on soaring prices, but very thin trading volumes for any credit product that carries any risk. Bill Finan, senior managing trader at Columbia Threadneedle told Bloomberg that he couldn’t remember seeing the Treasury futures market this thin and that this episode ranks with some of the more extreme liquidity crunches he’s seen. “Forget trading ultra [long maturity] bonds, nothing showing there,” he said.
Bloomberg also reported signs of stress in the short-term money market. The so-called FRA/OIS spread–seen by many as a proxy for banking sector risk–widened to as much as 51 basis points. That was more than double its level from earlier this week and well above the 12 basis points at the end of February. (The FRA/OIS spread measures the difference in rates between forward-rate agreements and overnight index swaps. An increase in the spread shows increased perception of a rise in interbank lending risk or dollar hoarding. ) One thing that seems to be happening is that bankers are reassessing the risk of their interbank lending “just in case” their overnight lending partner has something unknown but nasty hidden on its books.
Liquidity in the short end of the market has been an “issue” in recent months with the Federal Reserve pumping billions into the overnight Repo market.
Still this seems like an escalation of the problem. “We are staring at the abyss of a credit crunch,” Kaspar Hense, a portfolio manager at BlueBay Asset Management, told Bloomberg.
One of the causes is that the coronavirus has left bond buyers and traders scratching their heads over what companies (and maybe even countries) might be facing real problems in making interest payments as the coronavirus cuts into sales and tax revenues. This wouldn’t be such a big worry except that every player in the bond market knows that the world in general–on both corporate and government levels–is extremely over leveraged.