• Financial markets experienced extraordinary volatility in March as the COVID-19 pandemic worsened
  • A self-imposed social lockdown is sending shockwaves across the global economy, but policymakers have responded with substantial monetary and fiscal support
  • The Fed has “taken the gloves” off with a swift and decisive response of rate cuts, unlimited bond purchases, and liquidity/credit facilities
  • The ultimate economic cost will depend on the perception of virus containment and a safe return to public gathering

It’s difficult to find the right words to describe the events of the last few weeks for financial markets and the global economy. The rapid spread of COVID-19 across the globe has sparked severe shocks to all financial assets amid an unprecedented self-imposed economic shutdown for the world’s largest economies. Social distancing guidelines in the United States have effectively shuttered discretionary consumption, and as a result, unemployment claims spiked to 6.65 million, quadrupling the previous record set in 1982. The week of March 16 was particularly unsettling for fixed income markets. On March 15, the FOMC initiated a second emergency action in less than 2 weeks, slashing the fed funds rate 100 bps to the zero bound and announcing a $700 billion quantitative easing (QE) program. The Fed also re-launched multiple Great Recession credit/liquidity facilities to help smooth market functionality (more on this below). Treasury yields initially priced lower on that Monday morning, but as the day/week progressed, liquidity deteriorated for even the most liquid sectors (Treasuries and Agency MBS), despite the Fed’s purchases having already begun. In short, all assets were for sale that week, even gold, which ended the week 5% lower despite massive monetary accommodation and the risk-off tone in global markets.

The broad panic sparked what was effectively a run on the markets, leading to significant fund redemptions and deleveraging. Large banks and broker-dealers were either unable (balance sheet constraints) or unwilling to step in as the marginal liquidity providers, and as a result, spreads widened significantly for all sectors and across the credit quality spectrum. For veteran market participants, the sudden surge in liquidity premiums brought back memories of 2008, although the catalysts were very different. In the prior crisis, poor mortgage underwriting, excessive leverage, and subpar risk management practices led to a financial crisis, which ultimately froze credit and liquidity in fixed income markets. Over time, the Fed intervened with unprecedented measures, many of which were reintroduced last month. In the current crisis, overall economic and financial conditions were much more sound given post-crisis regulatory measures, particularly in the banking sector. However, the primary concern that emerged during the week of March 16 was that a liquidity crisis could quickly morph into an outright financial/credit crisis. To the Fed’s credit, they were more prepared to act quickly this time around, and with financial conditions rapidly deteriorating, they effectively took the gloves off. 

The Gloves Come Off
On March 15, the Fed had announced a $700 billion QE program, including $500 billion of Treasury purchases and $200 billion of agency MBS. By the end of the week, nearly half of those purchases had already been executed, with the central bank incrementally increasing purchases as the week progressed to combat dislocations in those markets. The market was simply overwhelmed with a deluge of bid lists, culminating on Sunday, March 22, with what might be the first weekend investor bid list in modern market history. To the Fed’s credit, they were closely monitoring these events and regularly soliciting feedback from active market participants, and on the following Monday morning, yet another FOMC statement was released.

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