June 17th, 2020
Last Thursday the S&P 500 index posted its worst one-day drop since March 16. The markets turned bearish as the reopening of the economy caused concerns about a second wave of the pandemic. Investors were worried that some US states may have to re-impose lockdowns because of the spikes in coronavirus cases. What we have is a pandemic-indexed S&P 500 nowadays, rising or falling with Covid news.
This week the market sentiment has been lifted with several positive economic news: The advance retail sales in May (both seasonally and inflation adjusted) posted 17.7 percent increase over April. The market’s expectation was less than 10 percent monthly growth. The retail sales were only 6.3 percent below the level of May 2019.
Another positive development was on the job front. According to the US Department of Labor press release, the downward trend of unemployment insurance claims continues. In the week ending June 6, the advance figure for seasonally adjusted initial claims was 1,542,000, a decrease of 355,000 from the previous week’s revised level.
In addition to these early signs of economic recovery, there has been a report about a drug (dexamethasone) as an effective treatment for the Covid-19 patients. The news let the S&P 500 index to rally in the last two days. It is inevitable that the markets will be swayed by news related to treatment options or potential vaccines till the pandemic is fully contained.
Pouring more money to make a ‘V’ out of ‘U’
From the policy-makers side, two developments have contributed to the bullish sentiment of this week. Firstly, the Trump administration proposed a $1 trillion infrastructure plan. We think this plan signals markets the government’s commitment to doing whatever it takes to make a quick recovery possible. Forcing a ‘U’ shaped recovery to a ‘V-shaped’ one is a challenging task. Therefore, as a second measure, the Fed announced that it would buy individual corporate bonds on the secondary market. These bonds should have remaining maturities of five years or less. This move comes on top of the Secondary Market Corporate Credit Facility. The Fed was already purchasing exchange-traded funds which include investment-grade and some high-yield corporate debt.
We believe that the Fed’s purchases of the corporate bonds in the secondary market will support the tightening in credit spreads. Our monthly forecast for high yield spreads was already indicating tightening in June . We think the extra liquidity owing to the expansion of the bond-buying program might lead to further spread-tightening in coming weeks.