LONDON (Reuters) – Coronavirus panic is rocking stock markets and sharp declines in major indices are attracting public attention. Behind the scenes, however, there is less understood and potentially more worrying evidence that stress levels in critical arteries of the financial system are rising to dangerous levels.
Bankers, corporations, and individual investors are keen to provide themselves with cash and other assets that are considered safe in a downturn to help them get out of the chaos. This sudden escape to safety is wreaking havoc in bond, currency and credit markets on a scale not seen since the financial crisis a dozen years ago.
The main concern now, as in 2008, is liquidity: the immediate availability of cash and other easily tradable financial instruments – and of buyers and sellers who feel safe enough to do business.
Investors struggle with buying and selling US Treasuries, which are believed to be the safest of all assets. This is an extremely unusual occurrence for one of the most easily tradable financial instruments in the world. Financing in US dollars, the world’s most traded currency, is becoming increasingly difficult outside of the US.
The cost of funding funds that companies use to prepare payroll and other essential short-term needs increases for lower-rated companies in the United States. The premiums investors pay for taking out junk bond insurance are rising. Banks charge each other more for overnight loans, and companies draw on their lines of credit in case they later dry up.
Taken together, some bankers, regulators, and investors warn, these red flags paint a troubling picture for markets and the global economy: If banks, corporations, and consumers panic, they can spark a chain of cuts that leads to a major funding crisis – and ultimately a deep recession.
Francesco Papadia, who oversaw the European Central Bank’s market operations during the region’s debt crisis a decade ago, said his greatest fear was that “market illiquidity caused by extreme uncertainty and panic reactions” “will freeze markets Could lead to what is an economic life threatening problem. “
“It doesn’t seem to me that we’re there yet, but we could get there quickly,” said Papadia.
A sign of the times is a hashtag that’s now trending on Twitter: # GFC2 – an indication of the possibility of a second global financial crisis.
The warning signals to date are nowhere near as loud as in the 2008-2009 financial crisis or the 2011-2012 debt crisis in the eurozone. And the policy makers are very aware of the weaknesses of the financial market installations. In the past few days, they have intensified their response.
The central banks have lowered interest rates and pumped trillions of dollars in liquidity into the banking system. On Sunday, the US Federal Reserve cut interest rates to near zero, restarted bond purchases, and partnered with other central banks to ensure dollar loan liquidity and support the economy.
“The only thing central banks know from the 2008 experience is how to prevent a financial crisis from occurring,” said Ajay Rajadhyaksha, head of macro research at Barclays Plc and a member of a committee that advises the US Treasury Department on debt management and administration issues the economy.
FILE PHOTO: Traders work the floor of the New York Stock Exchange shortly after the closing bell in New York, United States, on March 13, 2020. REUTERS / Lucas Jackson
TODAY VS 2008
While the panicked markets are reminiscent of the 2008 financial crisis, comparisons only go so far. Central bankers have fresh memories of the shocks of the past decade. Another key difference: banks are in better shape today.
In 2008, banks had far less capital and liquidity than they do now, said Rodgin Cohen, senior chairman of Wall Street law firm Sullivan & Cromwell LLP and a top advisor to major US financial firms.
Instead, according to investors and analysts, the risk this time lies in the effects of the pandemic on the real economy: shops with shutters, travel bans and parts of the workforce who are sick or quarantined. The freeze is a severe blow to corporate revenues and profits and macroeconomic growth, and there is no end in sight.
Nationwide quarantines to block the virus, such as in Italy, mean “businesses will be hit hard in terms of revenue and revenue,” said Stuart Oakley, who oversees currency trading for clients at Nomura Holdings Inc. are still the same : If you own a restaurant and borrow money to rent it, you still have to make this monthly payment. “
The economists at JPMorgan Chase & Co expect global growth to decline in the first half of the year. And this is because the U.S. response to the coronavirus is only beginning.
GRAPHIC: Coronavirus hits financial markets –
RED FLAGS
Investors and regulators were particularly alerted by liquidity problems in the US Treasuries market of $ 17 trillion.
There are several signs that something is wrong. The interest rates or yields on government bonds and other bonds move inversely to their prices: when prices fall, yields rise. Changes are measured in basis points or hundredths of a percent.
Typically, the returns are hovering around a few basis points per day. Now large and unusually rapid fluctuations in returns make it difficult for investors to execute orders. Traders said Wednesday and Thursday traders widened the price differential at which they were willing to buy and sell government bonds significantly – a sign of decreased liquidity.
“The tremor in the financial market is the most threatening sign,” said Papadia, the former ECB official.
Another alarming signal is that premium borrowers outside the US are ready to pay for access to dollars, a widely watched gauge of a potential money crisis. The three-month euro dollar EURCBS3M = ICAP and dollar yen JPYCBS3M = ICAP Swap spreads rose to their highest level since 2017 before falling on Friday after central banks pumped in more cash.
A measure of the health of the banking system flashes amber. The Libor OIS spread USDL-O0X3 = R.which indicates that the risk banks are cross-lending has increased. The spread is now 76 basis points, up from 13 basis points on February 21, before the coronavirus crisis began in the west. In 2008 it peaked at around 365 basis points.
GRAPHIC: Dollar Funding –
WEAK CORPORATE CONNECTION
As the finance markets creak, highly indebted companies are feeling the heat.
Rating firm Moody’s warns that lower-rated corporate bond defaults could rise to 9.7% of outstanding debt in a “pessimistic scenario”, compared to a historical average of 4.1%. The default rate reached 13.4% during the financial crisis.
The cost of junk debt insurance rose on Thursday to its highest level in the US since 2011 and the highest in Europe since 2012.
Some companies are now paying more for short term loans. The premium that investors charge to hold riskier commercial paper versus its safer equivalent rose this week to its highest level since March 2009.
Several companies are drawing on their lines of credit with banks or expanding their facilities to ensure they have liquidity when needed. Bankers said companies fear lenders will not be able to fund agreed lines of credit if market turmoil intensifies.
A major central bank official said the situation was “pretty bad as all the stars are negative”. “Cracks will soon appear,” said the official, “but it is still difficult to say whether they will develop into something systemic.”
Additional coverage from Sujata Rao and Yoruk Bahceli in London, Tom Westbrook in Singapore, and Lawrence Delevingne and Matt Scuffham in New York; Adaptation by Paritosh Bansal, Mike Williams and Edward Tobin
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