Main points:

*Cash is the current overriding concern for individuals, companies and suppliers

*The outlook is turning more negative on government bonds

*A single, pan-European bond issue could be moving closer to reality

The European Central Bank’s (ECB) latest (and much larger) response to the market fallout from the Covid-19 crisis is far more impressive than what it initially pledged last week, and more in line with what the market had been hoping for. The ECB’s initial response to the crisis had been to announce only a modest increase in its quantitative-easing (QE) programme, and this, together with very poor market liquidity, pushed sovereign spreads in the euro area wider versus German bunds, defying comments from ECB President Christine Lagarde that this would not be allowed to happen.

This latest €750bn debt-buying package is notable not only for its size, but because for the first time it includes Greek government bonds in the purchase plan. We would anticipate that these purchases should provide some backstop to the rise in non-German sovereign-bond yields, along with extra support for the corporate bond market.

Given the US Federal Reserve’s experience with QE this week (it had already spent $175bn and yields still rose, it wouldn’t surprise us if the ECB comes back to the table for a third time to promise further financial support to bolster the escalating fiscal deficits around the eurozone.

Turning negative on government bonds

The occurrences of the last few days have led us to turn negative on government bonds, because as economies run the risk of grinding to a standstill in the current crisis, cash becomes the overriding concern for individuals, companies and suppliers who need to get paid.

The central banks are trying their best by slashing interest rates, but it is the availability of money that is the problem, rather than its price. For us, government spending through initiatives such as tax cuts, benefit increases or loan guarantees is the only answer, as such actions will supply the necessary cash to allow businesses and individuals to keep going.

QE helps because it finances some of the government spending, but it will still require a substantial issuance of bonds, which is putting upwards pressure on bond yields as we have seen play out this week. In these unprecedented times, as has been mooted again over the last couple of days, a pan-eurozone bond where all members issue as one group, could be on the cards. Could Germany finally be willing to share its AAA credit quality?

Comments

Your email address will not be published.

Newton does not capture and store any personal information about an individual who accesses this blog, except where he or she volunteers such information, whether via email, an electronic form or other means. Where personal information is supplied, it will be used only in relation to this blog, and will not be collected or stored for any other purpose. Comments submitted via the blog are moderated, and, as a result, there may be a delay before they are posted.

This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors. Please note that holdings and positioning are subject to change without notice.

Important information

This material is for Australian wholesale clients only and is not intended for distribution to, nor should it be relied upon by, retail clients. This information has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person. Before making an investment decision you should carefully consider, with or without the assistance of a financial adviser, whether such an investment strategy is appropriate in light of your particular investment needs, objectives and financial circumstances.

Newton Investment Management Limited is exempt from the requirement to hold an Australian financial services licence in respect of the financial services it provides to wholesale clients in Australia and is authorised and regulated by the Financial Conduct Authority of the UK under UK laws, which differ from Australian laws.

Newton Investment Management Limited (Newton) is authorised and regulated in the UK by the Financial Conduct Authority (FCA), 12 Endeavour Square, London, E20 1JN. Newton is providing financial services to wholesale clients in Australia in reliance on ASIC Corporations (Repeal and Transitional) Instrument 2016/396, a copy of which is on the website of the Australian Securities and Investments Commission, www.asic.gov.au. The instrument exempts entities that are authorised and regulated in the UK by the FCA, such as Newton, from the need to hold an Australian financial services license under the Corporations Act 2001 for certain financial services provided to Australian wholesale clients on certain conditions. Financial services provided by Newton are regulated by the FCA under the laws and regulatory requirements of the United Kingdom, which are different to the laws applying in Australia.