Uncategorized

Fat tails

| March 13, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The coronavirus story has come to include something for almost everyone: medicine, economics, markets, monetary and fiscal policy. None of these are settled yet and look likely to remain unsettled for months. The continuing swings in rates and spreads reflect a wide set of potential outcomes. The base case still remains containment of the virus, repair of most economic damage, and resetting of policy and markets to more normal conditions. The path there, however, could vary widely.

The range of US 10-year yields through the week of March 9 reflects the range of possibilities in the market. Yields touched 0.31% early on Monday and 1.01% late in the day Friday. The flow of information about the virus through the week reflected slowing outbreaks in China and Korea and accelerating outbreaks in Italy, Iran, the US and elsewhere. Evidence of potential economic damage outside of China became clearer as Russia and Saudi Arabia started an oil price war, some areas imposed or broadened quarantine, schools closed, more organizations canceled events, and travel and retail activity thinned out. Boeing and portfolio companies at Blackstone and Carlyle drew down lines of credit. The Fed on Thursday announced plans to offer $4.6 trillion in added repo funding over four weeks and extend Treasury debt purchases to longer maturities along the yield curve. And the White House announced Friday a series of emergency public health and economic measures, including purchases of oil.

All of these factors will interact for months. Public health officials have already started drawing lessons from the experience of China and Korea, which showed the virus can be contained by a combination of limiting public contact and broad testing. Economic damage arguably is the most difficult to predict, with small businesses, highly leveraged corporate balance sheets and their employees most at risk—none likely having enough liquidity to weather months of depressed earnings, higher costs or both. Policy may be able to fill in the gap.

Despite broadly good prospects for managing the crisis, a more visible, public phase is just about to start outside of China and Korea; it hard to anticipate public response. Cases in the US and other places are likely to rise substantially over the next few months putting severe pressure on healthcare systems. The supply of coronavirus tests in the US, at least, is running well behind demand. The available supply of US hospital beds does not anticipate a surge in cases of the magnitude possible with coronavirus. Market expectations and policy response could still swing significantly.

The sharp steepening in the US Treasury curve also points to the different directions of monetary and fiscal policy. The Fed still looks likely to cut sharply at its meeting on March 18, and fiscal response in the US and Europe looks likely to set a lower bound of economic activity.

Risk assets have gone a long way to pricing in a wide range of outcomes. Spreads in investment grade credit and agency MBS have widened to levels last seen during and shortly after the 2008 financial crisis. Spreads in high yield credit, leveraged loans and CLOs have widened to levels last seen during the energy crash of 2014 through 2016. Investors should buy fundamentally sound cash flows trading at these spreads, recognizing the risk of more market volatility.

Investors should also realize the value of liquidity, not just as an off ramp to safety but for its option value in buying sound cash flows at distressed prices.

In a market with a range of new factors at work, options on outcomes at either end of the range remain valuable.

* * *

The view in rates

The rate on 10-year notes has made a roundtrip from 0.76% on March 6 to 0.31% on March 9 to 0.96% on March 13. It reflects a wide range of shifting opinion on the virus, the economy and monetary and fiscal policy. The market has priced for nearly 100 bp of Fed easing by March 18. Both the Fed and fundamentals are likely to be different in the long run, but global flight to quality is likely to keep rates low until the links between the coronavirus, the economy, the Fed and fiscal policy play out.

The view in spreads

At current spreads, investors should add fundamentally sound cash flows in credit. That includes some higher quality corporate names and investment grade CLOs, which have strong structural protection in even severe scenarios. MBS spreads should remain under pressure from some of the fastest prepayments since 2012. MBS should underperform credit.

The view in credit

The immediate risk in credit is from companies with high fixed costs and a sharp drop in revenue from current efforts to avoid coronavirus infection. Companies with the highest leverage are first in line. As for the consumer, that is a story of generally continued strength with low unemployment, strong income, rising net worth and low debt service as a share of income.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2025 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

Important disclaimers for clients in the EU and UK

This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.

This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.

This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.

This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.

The Library

Search Articles