High yield entry timing
The timing of a vaccine to COVID-19 may be crucial in deciding when and how to invest in high yield bonds.
Markets Weekly
01 May 2020
4 minute read
Week ahead
The main focus next week will be the Bank of England’s Monetary Policy Committee (MPC) meeting on Thursday. The meeting follows aggressive measures taken by the institution in recent months to support the economy in response to the COVID-19 pandemic – including two emergency inter-meeting cuts totalling 60 basis points.
On the data front, early in the week the focus will be on the IHS Markit final purchasing managers’ index (PMI) for April in the eurozone, UK, US and China. Earlier estimates were sharply down, with the composite readings for the eurozone, UK and US at record lows of 13.5, 12.9, and 27.4 respectively (where a figure below 50 suggests economic output is contracting).
In China, the Caixin manufacturing and services PMIs recovered to 50.1 and 43.0 in March respectively, from all-time lows in February. The country was the first to implement strict quarantine measures before restarting activity in March. The pace of recovery after a period of quarantine will be an important gauge as to the potential pace of recovery in other economies with similar measures in place.
At the end of the week, Chinese trade numbers are likely to remain relatively weak, despite a modest improvement in March, as trading partners begin strict containment measures.
US non-farm payrolls data for April end the week. The March data showed job losses of 701,000, amid the pandemic. With weekly initial jobless claims comfortably breaking record highs of late, the April employment reading is expected to plummet.
Chart of the week
The world of negative oil prices
Paying someone for buy something you produced seems mad. But, a barrel of West Texas Intermediate (WTI) oil settled at (minus) -$38 on 20 April, something many thought would never happen. A unique combination of factors can explain this unprecedented move.
On one side, a collapse in demand owing to quarantine measures to counter the coronavirus outbreak (worth perhaps 30m barrels per day at the peak), efforts to pause production, and vanishing storage capacity contributed to the oil price weakness. On the other, technical, side, the expiration of May futures contracts at a time when investors poured billions of dollars into financial instruments tracking oil prices magnified the move.
As it turns out, “buying oil” is not as straightforward a proposition as it may sound. Indeed, most financial instruments available to the majority of investors aim to replicate the change in the oil price by buying the “front-month” futures contract and then rolling this position month after month. In normal times, this process can perform similarly to that of the quoted oil price.
However, most things are not normal these days, including the shape of the futures curve for various dates of delivery of the commodity. The collapse in demand for oil has caused the curve to invert, also called “contango”, with spot prices trading at a significant discount to future prices.
When this happens, rolling futures contracts from one month to the next has a significant cost, eating into returns. Unfortunately, there is no way around that unless you invest in contracts for delivery over a longer period and so minimise rolling costs.
The other option is to invest in oil companies. While imperfect, the correlation of the performance of the stocks with oil prices remains relatively high. Additionally, there are no additional costs caused by rolling over futures contracts. In addition, oil-related stocks tend to follow the “middle” of the curve, which is much more stable but will still likely head higher when demand rebounds.
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