Fed View: Yield caps could be the next step – Bond markets are continuing to sell off, despite dramatic central bank interventions over the past week. The drivers of the sell-off are not entirely clear, but it is likely that a surge in demand for cash in an extreme risk-off environment, combined with expectations for higher bond issuance due to announced and future fiscal stimulus, are the primary drivers. Whatever might be driving this, the Fed will be unnerved by the tightening of financial conditions in recent days. Alongside declining equity markets, US Treasury yields have jumped more than 70bp from their low on 9 March. Given this, while we had thought the immediate firefighting by the Fed was likely over following the ‘shock and awe’ 1pp rate cut and $700bn asset purchases announcement on Sunday, the subsequent backup in yields suggests the Fed’s work is not yet done.
We do not think the Fed will stand by while financial conditions tighten to this extent. Given that there are no calendar-based caps on purchases in its recently announced bond-buying programme, the Fed has the tools and the scope to intervene in markets and to bring yields back down. However, if yields fail to come down despite large-scale interventions, the Fed might opt to strengthen this and to more directly influence the market by announcing caps on bond yields. This could be accompanied by a ‘whatever it takes’-type commitment to go beyond the $700bn purchase amount if necessary. Yield caps were something Governor Brainard suggested as a possible new tool for the Fed, before the coronavirus crisis in markets erupted, and suggests it is a policy the FOMC would seriously consider. Should market conditions fail to calm in the coming days and weeks, such a step looks increasingly likely. (Bill Diviney)
Euro Macro: Germany’s business climate plunges – The first reports about the business climate in the eurozone in March have been published. In line with our expectations, the survey results all plummeted, as the economic damage of the outbreak of the coronavirus is kicking in. Germany’s ZEW economic sentiment (gauging expectations about the economy during the next six months; balance of ‘improve’ minus ‘get worse’) staged its largest monthly drop since the start of the series in December 1991. It fell to -49.5 in March, down from + 8.7 in February. Next, the Ifo business climate indicator also dropped the most since 1991, and plunged to 87.7 in March, down from 96.0 in February. The Ifo expectations component fell from 93.2 to 82.0, while the current conditions indicator fell from 99.0 to 93.8. The details of the Ifo report show that sentiment collapsed in all sectors of Germany’s economy. According to the written statement by the Ifo Institute ‘the drop in expectations in manufacturing is the single most precipitous in 70 years of industry surveys’. Moreover, in the services sector the business climate indicator saw the greatest fall since the records began in 2005. In retail trade and wholesale trade sentiment fell to the lowest level since German reunification. Finally, even in the construction sector, which seems to be the sector that initially is affected the least by the outbreak of the coronavirus, the expectations index deteriorated notably. All in all, the first set of monthly surveys for the eurozone business climate in March clearly signal that the region is entering a deep recession. Indeed, we expect eurozone GDP to contract by around 1.8% qoq in Q1 and around 3.2% qoq in Q2 of this year (see here). (Aline Schuiling)