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Global Markets and Macroeconomic Policy ResponsesFinancial Markets and the Fed in the COVID-19 Pandemic
Robin GreenwoodVictoria IvashinaAdi SunderamApril 14, 2020
1
Global Markets and Macroeconomic PolicyFinancial Markets
Faculty and Guests
2
Robin Greenwood
VictoriaIvashina
AdiSunderam
Paul Tucker
Chair, Systemic Risk
Council
BoazWeinstein
Saba Capital
AndréPeroldHighVistaStrategies
DavidAbrams
Abrams Capital
Global Markets and Macroeconomic PolicyFinancial Markets 3
https://projects.iq.harvard.edu/covidpt
Global Markets and Macroeconomic PolicyFinancial Markets
Agenda
4
Equity Markets Bond Markets CLOs and & the Fed Corporate Liquidity
Global Markets and Macroeconomic PolicyFinancial Markets
Equity Markets
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Global Markets and Macroeconomic PolicyFinancial Markets 6
0
50,000
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500
1000
1500
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2500
3000
3500
40001/
22/2
020
1/29
/202
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2/5/
2020
2/12
/202
0
2/19
/202
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2/26
/202
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3/4/
2020
3/11
/202
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3/18
/202
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3/25
/202
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4/1/
2020
4/8/
2020
Cum
ulat
ive
Cas
es
S&P
500
SP500 vs. US Confirmed Cases
S&P 500 US Confirmed Cases
1
10
100
1,000
10,000
100,000
1,000,000
0
500
1000
1500
2000
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3000
3500
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1/22
/202
0
1/29
/202
0
2/5/
2020
2/12
/202
0
2/19
/202
0
2/26
/202
0
3/4/
2020
3/11
/202
0
3/18
/202
0
3/25
/202
0
4/1/
2020
4/8/
2020
Cum
ulat
ive
Cas
es (L
og S
cale
)
S&P
500
SP 500 vs. US Confirmed Cases
S&P 500 US Confirmed Cases
Global Markets and Macroeconomic PolicyFinancial Markets
Global Market Responses
7
60
65
70
75
80
85
90
95
100
105
110
Retu
rn In
dex
S&P 500 Nikkei 225 Hang Seng DAX
Global Markets and Macroeconomic PolicyFinancial Markets
Cash flows and discount rates
Near-term cash flow news is extremely negative, but markets have already started to look beyond this year
How much of the movement in prices is changes in discount rates, or risk aversion?
Policy influences both the numerator and the denominator
8
𝑃𝑃0 =𝐹𝐹𝐹𝐹𝐹𝐹11 + 𝐾𝐾
+𝐹𝐹𝐹𝐹𝐹𝐹2
1 + 𝐾𝐾 2 +𝐹𝐹𝐹𝐹𝐹𝐹3
1 + 𝐾𝐾 3 + ⋯
Global Markets and Macroeconomic PolicyFinancial Markets
Discounting (Disciplining) Arithmetic
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Dollar Growing at Rate 3% 5% 3% 5%
Discount Rate 8% 8% 10% 10%
Fair Value 20.0 33.3 14.3 20.0
Year 1 as % of Value 5% 3% 6% 5%
Global Markets and Macroeconomic PolicyFinancial Markets
Recovery from dark days
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0.00
20.00
40.00
60.00
80.00
100.00
120.00
140.00
160.00
Real Earnings of S&P 500
Source: Robert Shiller
Global Markets and Macroeconomic PolicyFinancial Markets
Daily
/Wee
kly
indi
cato
rs
11
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
1-Mar 8-Mar 15-Mar 22-Mar 29-Mar 5-Apr
TSA Daily Throughput
2020 2019
-120-100
-80-60-40-20
02040
Dec
line
rela
tive
to 2
019
Restaurant Reservations Y-O-Y
Restaurant Reservations- MARestaurant Reservations- NY
-10
-8
-6
-4
-2
0
2
4
6
31 D
ec 2
007
31 D
ec 2
008
31 D
ec 2
009
31 D
ec 2
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31 D
ec 2
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31 D
ec 2
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31 D
ec 2
013
31 D
ec 2
014
31 D
ec 2
015
31 D
ec 2
016
31 D
ec 2
017
31 D
ec 2
018
31 D
ec 2
019
Stock et al Weekly Economic Indicator
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1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
7,000,000
8,000,000
8-18
-200
78-
18-2
008
8-18
-200
98-
18-2
010
8-18
-201
18-
18-2
012
8-18
-201
38-
18-2
014
8-18
-201
58-
18-2
016
8-18
-201
78-
18-2
018
8-18
-201
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Initial Claims
Sources: OpenTable, TSA, FRED, Jim Stock
Global Markets and Macroeconomic PolicyFinancial Markets
US Sector Returns
12
-13% -15%
-8%
-44%
-24%
-7%
-22%
-16%
-8% -7% -6%
-50%
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
Source: Based on YTD returns from SPDR Sector ETFs
Global Markets and Macroeconomic PolicyFinancial Markets
Equity Markets Panel
How do you make sense of markets today?
13
AndréPeroldHighVistaStrategies
DavidAbrams
Abrams Capital
Global Markets and Macroeconomic PolicyFinancial Markets
Bond Markets and the Fed
14
Global Markets and Macroeconomic PolicyFinancial Markets
Bond Markets and Fed Interventions
Chaos in markets in early March Some similarities to the GFC: runs, market freezes
Federal Reserve deployed its entire 2008-09 playbook Took almost a full year in the GFC
Two weeks this time around
Markets have stabilized following these massive interventions
More to be done as bond markets have changed dramatically since 2009
15
Global Markets and Macroeconomic PolicyFinancial Markets
US Treasury Yields Tumble
16Source: Federal Reserve Board of Governors
Global Markets and Macroeconomic PolicyFinancial Markets
Credit Spreads Soar
17Source: Federal Reserve Board of Governors
Global Markets and Macroeconomic PolicyFinancial Markets
Flows out of Corporate Bond Funds
18Source: Morningstar
Global Markets and Macroeconomic PolicyFinancial Markets
High Yield Bond Issuance Collapses
19Source: SIFMA
$0
$5
$10
$15
$20
$25
$30
$35
$40
Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20
US Corporate Bond Issuance, Jan 2019 - Mar 2020 (in $ billions)
Global Markets and Macroeconomic PolicyFinancial Markets
What has the Fed done?
Conventional: Cut federal funds rate to zero. Quantitative Easing: buying Treasuries and MBS Liquidity Support
Dealers Money market funds Asset-backed securities
New: Credit markets Investment grade firms State and local governments High yield and small firms
20
Global Markets and Macroeconomic PolicyFinancial Markets
History doesn’t repeat…but it rhymes
What’s the same
Liquidity or solvency?
Flight to quality
Runs and market freezes outside traditional banks
The Fed saves the world
21
What’s different
Firms not banks (so far)
Flight to cash
Shadow lending, not shadow banking
?
Global Markets and Macroeconomic PolicyFinancial Markets
Bond Markets Panel
How is credit priced today?
What is different between today and the GFC?
22
Paul Tucker
Chair, Systemic Risk
Council
BoazWeinstein
Saba Capital
Managing the Liquidity Crisis
23
Global Markets and Macroeconomic PolicyFinancial Markets
Managing the Liquidity Crisis
24
https://hbr.org/2020/04/managing-the-liquidity-crisis
Global Markets and Macroeconomic PolicyFinancial Markets
The Starting Point
Prof. Victoria Ivashina When a Pandemic Collides with a Leveraged Global Economy
Unprecedented Corporate Leverage
Economic consequences
of COVID-19
Massive Liquidity NeedDowngrades
+
Global Markets and Macroeconomic PolicyFinancial Markets
Leveraged Loan Market: The Focus is on CLOs
26
• CLOs: Collateralized Loan Obligations
Global Markets and Macroeconomic PolicyFinancial Markets
Why Won’t CLOs Provide Additional Capital:Binding Mechanisms
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• By design, the structure has a “live” restructuring mechanism built in
Absolute seniority
Liabilities:
Mezzanine Notes
Senior Notes
Collateral pool
$
Downgrades
Equity
Global Markets and Macroeconomic PolicyFinancial Markets
CLOs: The Roadblock of the Large Cap Space
28
Liabilities:
Mezzanine Notes
Senior Notes
Equity
Through the CLO covenants (eligibility & O/C): • CLO is either prohibited• Or equity is heavily
disincentivized to inject additional capital (as it comes directly from the value of equity)
Global Markets and Macroeconomic PolicyFinancial Markets
One More Fact: Abundance of Private Capital
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• Global “Dry Powder” (upper bound)A solution to the problem should lever funds and expertise of private capital
Source: Preqin
Global Markets and Macroeconomic PolicyFinancial Markets
CARES Act
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Although substantial ambiguity about the exact implementation remains, In its current form:
It does not adequately lever private capital
E.g., MSNLF MSELF are constrained to banks and S&Ls
It leaves the CLO “roadblock“ in place, and works around it (ironically, exploiting the room for additional leverage under the weak covenants)
It leaves out large firms and the most urgent situations (>6x Debt/EBITDA)
For leveraged borrowers, it is poorly designed in terms of incentives
Global Markets and Macroeconomic PolicyFinancial Markets
Thank you!
Stay tuned for additional sessions Macroeconomic Policy Responses to the COVID-19 Pandemic
(This Thursday and Friday)
Economics Discussion with Larry Summers (Monday April 20)
31
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