The rate futures market is now pricing in three rate cuts from the Fed this year with the first expected in March on the back of supply disruptions due to the virus. Ten-year treasuries are trading at all-time lows, as is the long bond, with two and five year UST trading below the 1% yield level. Credit is lagging this move with spreads widening and some prices have eased off a little in sympathy with the fall in stock markets. So we have a true flight to quality, safe havens are outperforming as investors look at capital protection. As one client once told me “Loss of capital is loss of life” during such events.
Yesterday ECB president Lagarde commented that the virus did not yet require any ECB response, in line with the Fed member Evens who said the situation does not warrant a Fed reaction yet. But this has not stopped the market pricing in a global easing from the central bankers. In the UK, the market is now pricing a BoE 25bp cut in March at more than a 60% probability and the Bank of Japan are widely expected to provide further assistance to the market next month at their meeting.
However, can the central banks save the day, would they want to, except to perhaps stabilise confidence? The global economy had problems before the virus, China and Europe especially with growth in mind. What was needed before, and still is required, is fiscal input from governments. Central banks have carried the weight of the world for too long and are running out of ammunition.
Also … 25 years ago this week a certain Mr Leeson broke Britain’s oldest investment bank, Barings. At the time he was the 28-year-old head of derivatives in Singapore when it was discovered that he had more than USD1bn of unauthorised and unhedged speculative trades. The original idea was for Leeson to arbitrage future contracts on the Nikkei 225 between the Singapore International Monetary Exchange and the Osaka Securities Exchange. However, rather than simultaneously trading both contracts and taking the small profit, he went long of the future in the hope of creating a much bigger profit. It was a trade that had worked very for him in the past, at one point his book accounted for 10% of all Barings profits. Every time he had lost money he had recouped it using a ‘doubling’ strategy. However, then Mother Nature intervened in the form of the Kobe earthquake and this time the numbers were much bigger.
Lesson was long (and very wrong) of the Nikkei 225 futures when the earthquake hit. However, due to knowledge of settlements and back-office procedures, he was able to his shield his positions by manipulating the internal accounting systems, (the now famous 88888 error account) so no-one was the wiser. The world was in the dark until he sent a letter of confession to Peter Baring, the chairman of the bank. The total loses reached approximately USD1.4bn, twice that of Barings's available trading capital. Three days later, after a failed bailout attempt, the merchant bank, which had been in existence for 233 years folded.