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Capital Markets Weekly: Market volatility to remain severe amidst flight to cash

20 March 2020 Brian Lawson

Debt market overview

Volatile bond yields

Volatility has remained extreme as COVID-19 has spread rapidly, triggering growing restrictions on economic activity globally. Risk aversion is severely impacting European and Emerging markets.

European government bond yields rose sharply for much of the week, peaking on 18 March before dropping rapidly in response to the ECB's EUR750 billion Pandemic Emergency Purchase Program.

Prior to the ECB announcement, Spain's 10-year bond yield closed on 18 March at 1.22%, having risen to 1.28% during the day, versus 0.26% on 11 March. In response to the PEPP, it traded as low as 0.73% and now stands at 0.76% (9 am London time, 20 March).

Over the same period: Italy's 10-year yield has moved from 1.18% to 2.68% on 19 March (closing at 2.43%), falling after PEPP to open at 1.4% (and now trading at 1.60%)

Similar trends apply to France and Germany: 10 year OATs moved from a low of -0.38% on 9 March to close at + 0.35% on 18 March, before dropping to 0.17% after PEPP (now 0.14%), while Germany's 10 year Bund backed up from a month low of -0.9% to -0.23% on 18 March, before dropping back to -0.28%.

Flight to cash

According to a Reuters report on 20 March, Lipper data showed a record outflow of USD55.9 billion from taxable bond funds in the week to 18 March. The same report cited US equity fund outflows of USD7.45 billion, with money market funds gaining USD148 billion, a second successive record.

A Financial Times report, citing EPFR data, claimed that total outflows from bond funds reached USD109 billion in the same one-week period, including record outflows from high-grade corporate debt and sub-investment grade bonds. Equity funds were recorded as losing USD20 billion (after a USD23 billion outflow last week), while money market funds enjoyed inflows of USD95 billion, after USD136 billion of inflows in the preceding week.

This risk aversion has translated into a sharp reversal in the prior downward trend in US bond yields: as of 20 March, ten-year US Treasuries yield 1.16%, having traded below 0.7% during Asian trading on Monday 16 March.

Emerging markets: Weakness

On 16 March, Argentina's EMBI+ spread widened four full percentage points to 3467 basis points, a 13.2% daily variation in its margin over US Treasuries, and closed on 19 March at 4050 b.p. Ecuador faced a similar four percentage point jump on Monday to 3869 b.p., a 12.2% change in spread on the day. On 18 March, Argentina's spread jumped again, by 423 basis points to 3926 b.p , but the most dramatic move was for Venezuela after the Maduro administration's application to the IMF was rejected: Venezuela's EMBI+ spread rose 2688 basis points on the day to 15234 b.p. (implying an average yield of 152% on its bonds). Despite the huge capital discounts such yields imply, they still fall short of the 206% yield recorded by Venezuela's EMBI index in late 2019.

An Angolan presidential decree on 18 March authorized the appointment of banks to conduct an international bond sale worth up to USD3 billion. However, issuance seems near-impossible currently. Angola's 2025 debt was last recorded trading at around 23.5% yield and the average spread on Angola's dollar debt recently was quoted at over 16 percentage points over US Treasuries. These are clearly distressed levels making any sale unrealistic.

High grade debt: Periodic active supply

On 13 March three US firms - Ohio Power, medical equipment company Zimmer Biomet and Entergy Arkansas - accessed the market. Ohio Power's USD350 million 10-year deal was priced at a 170-basis point margin over US Treasuries, versus guidance of 185 b.p.

After a one-day pause on Monday (16 March) given dramatic US stock price falls, supply restarted on Tuesday 17 March. Exxon undertook a five-part package, paying a premium to companies with lower investment grade ratings, reflecting adverse investor perceptions of energy sector risk (Brent crude prices fell this week below USD30/barrel). Nine companies issued overall in the US dollar sector on the day, including Verizon, Bank of America and Progressive Corp: total supply reached USD25 billion.

A further surge in supply took place on 19 March. According to IFR, seven US high-grade deals were completed, howbeit at sizeable new issue concessions. Of these, Walt Disney obtained USD6 billion of new funding in a five-tranche package, with maturities spanning from 2025 to 2050. It placed USD750 million and USD1.75 billion respectively for 20 and 30 years, at 4.625% and 4.7% respectively. Proceeds are for general corporate purposes including the repayment of existing debt.

Our take

This week's report continues to reflect the exceptional market conditions prevailing. Given widespread and growing lockdown measures in Europe, and COVID-19's spread in the USA, the likelihood of a deep recession is growing, despite governments ramping-up their fiscal measures.

Unlike in prior weeks, government bond yields started the week with upward pressure in yields - even in countries like Germany which enjoy safe-haven status. This appears logical given the flight to cash, and on fundamental grounds, notably the curtailment of fiscal receipts and heavy additional spending governments need to make, including widespread measures to protect firms from temporary curtailment or near-total loss of business.

Calls for direct state aid -most immediately by the airline sector - will continue growing, but fiscal moves also will include increasing benefits, substantial expansion of health and welfare spending, and support to encourage continued bank lending (such as the UK's guarantee scheme for business lending). Given growing risks of corporate defaults, state funding to support the banking sector and multiple industry groups seems likely.

Indicators of risk deterioration are acute, and point to severe financial stress:

  • Between 18 February and 18 March 2020, the KBW Nasdaq Global Bank Index of bank share prices fell from 858.7 to 559.8: it has lost 36% in 2020. Some banks have halved in value and/or are now trading at below half their book values.
  • From consistently narrow discounts to parity, secondary US leveraged loan valuations have fallen to 84% of nominal value according to Loan Syndications and Trading Association data published by the Financial Times on 17 March, their weakest level since August 2009.
  • US sub-investment grade bond spreads have more than doubled within 2020, rising by a full percentage point to 8.4% over US Treasuries on 16 March: earlier this year, they reached a low margin close to 3.5%.
  • Emerging market spreads already have been badly affected, particularly for energy dependent countries: as an example, Ecuador's EMBI+ spread peaked at 3869 basis points over UST on 16 March, versus just 774 b.p. on 6 January. With issuance having dried up, and emerging market dedicated funds facing heavy redemptions, default risks have worsened sharply. Other energy-intensive countries, such as Angola and Nigeria, are among the obvious candidates to face debt sustainability challenges and problems in the months ahead.


  • Government finances face severe pressure, through curtailed revenues and higher outlays: even countries with sound finances and safe-haven status like Germany face deteriorating economic and fiscal dynamics.
  • Investor confidence is clearly badly damaged, with a flight to cash. This will force further asset liquidations and is likely to lead to funds facing liquidity squeezes forcing "lock-ins".
  • Increased government bond yields imply mark to market losses for on their government bond holdings, exacerbating capital pressures.
  • Risk aversion - and the collapse in bank share prices - removes scope for financial entities to raise new capital: with asset quality deterioration and capital positions facing severe pressures, recourse to government help to preserve structural stability is increasingly likely.

Overall, it is hard to quantify risk in such a fast moving and risk-adverse situation, driven by the adverse combination of two significant shock events: COVID-19 and the breakdown of OPEC price discipline. The combination of market imbalances and forced redemptions suggest that movements will continue sharp and subject to sudden changes: new issue windows for debt are likely to be temporary, used rapidly, and focused towards higher-quality issuers.

As a closing note, emphasizing the severity of current dynamics, IHS Markit Energy specialists published forecasts on 19 March that Brent oil prices could fall to USD12 per barrel in April and a floor of USD10 in May (versus USD55.49 in February 2020) under a scenario of temporary demand collapse - not our worst-case scenario. Under the latter, it could take until late 2021 before even USD20 a barrel is achieved once again. With this implying the shut-in of at least part of US production capacity and having severely-damaging impacts for energy producing states, downside risks remain extremely high, with leveraged loans and junk bonds badly exposed.

Posted 20 March 2020 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence



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