Authored by BMO Capital Markets rates strategists Ian Lyngen, Ben Jeffery and Jon Hill
It’s Wednesday morning – or effectively Thursday afternoon when accounting for Friday’s market holiday and tomorrow’s early close. Yep, still counting the hours to the long weekend; gotta have a goal. Suffice it to say, the pace of trading, volatility, macro developments, policy responses, and the outbreak itself resulted in the year-long month of March – at least it felt that way. This week has brought with it a sense of market calm and budding optimism largely lacking in the crisis up to this point. This followed what appears to be a plateau in Covid-19 in parts of Europe and the subsequent extrapolation of the overseas timeline to the domestic outbreak. What remains to be seen is whether the experience in other nations truly translates onshore.
In assessing this question, investors will continue to track the incoming coronavirus stats and gauge the official response. Lockdown life will continue for the time being, even as the macro conversation has shifted to reopening strategies and the prospects of getting back to the new normal.
This is a generation defining episode in world history; an observation which isn’t intended as needless hyperbole. The fact of the matter is that investor and consumer behavior will change in the wake of the current health crisis… for a while.
The reality of emptied college campuses, mothballed air fleets, shuttered car plants, and retail ghost towns will have a dramatic impact on the labor force statistics over the coming months; a massive drain, followed by a reemployment surge. This much is easy enough to envision, if not perfectly forecast. The next major unknown is how the reopening transpires – and of course when.
Trump is reportedly crafting a plan to reopen certain sections of the economy not particularly hard hit by the coronavirus, while keeping areas still struggling with significant cases shuttered; New York is top of mind in this regard. Partial reopenings will be undoubtedly be the unifying theme of the headlines on this topic over the course of the next several sessions and our expectation is that it will be a net positive for risk assets. Before investors can move forward with estimating the cost of the outbreak in economic terms, an end date is required and this has become the market’s newest preoccupation. Our take is there will be an eventual return to pre-virus normality, but the timeline will be measured in quarters, or years – not weeks or months.
This brings us to the current stage of evaluating the leg in Treasury yields. Our base case for this week remains the process of defining the near-term range will extend – although to a large degree there are a several key levels already in place. In 10-year yields there are two trading zones to watch; the narrower at 56.4 bp to 89 bp and the broader at 31.4 bp to 127.3 bp. The tighter range has held since March 23 and there is no reason to anticipate it breaks in the coming weeks. It will take a concrete reopening schedule and significant progress in battling Covid-19 in the US before 1-handle 10s return to the realm of conceivable outcomes.
The very front end of the curve is going to remain in a much narrower and lower range for a very long time – 2s at 25 bp appears to be establishing some semblance of equilibrium. Negative front-end yields are still on our radar in the event of another risk-off impulse from new depths of the economic fallout expectations; the bounce in risk assets has lessened the urgency for the sector at the moment. It’s difficult to envision another liquidity crunch and dash for cash comparable to that seen during March, therefore another repricing to lower rates will be a slow and methodical grind as recovery prospects eventually come into finer focus.