12 March 2020 – The US Federal Reserve (US Fed) has made an emergency interest rate cut of 50bps in light of the risks on the economy posted by the coronavirus (COVID-19). While initially equity market surged on the news, the rally was not sustainable, and the US market closed 9 March by almost 3% down. On the other hand, bond yields fell on the back of the expectation of further interest rate cuts. The US 10-year treasury yield went below 1% for the first time in history.
Market reactions come as no surprise
In fact, the US Fed’s action and the market reactions come as no surprise to us. Our Global Asset Allocation Committee concluded in a meeting held last Monday that a response from central banks is expected shortly and should be able to help stabilise sentiment.
Even though we do not believe that lower interest rates will re-ignite the economic recovery, we do believe that they still have an important effect on valuations and the continuation of liquidity-fuelled equity returns. Yet, this is not a time for blithe risk-taking.
Before wading back into risk assets, we will need to see evidence of a peak in infection rates or more information on the economic damage in the form of corporate earnings announcements or economic data.
Look through short-term noises
With the above said, what happened overnight did not change our view and strategy.
The pressure on equities is from the financial sector as lower yields and interest rates are going to put pressure on their margins.
On REITs, while the impact on rentals is likely to be less felt in offices given the long-term contract with tenants, we are likely to see more immediate impact on retail REITs given the fall in visitors and that rental concessions have already started. Against the current environment, telecoms and utilities remain the safe-haven play.
As for asset allocation, as mentioned above, fundamentally we believe that we should look through short-term noises and focus on the medium-term fundamentals, which at this moment continue to be strong.
Our Asian Multi-Asset strategy is defensively positioned with reduced equity exposures. We are also holding on to hedges such as duration and safe-haven currencies, such as USD and JPY. The expectation of further actions by central banks shall remain positive for carry / income assets. Hence, we will continue to keep them in our strategy.
We believe that it is unwise to take any aggressive actions or positions now. Being patient for more confirmation and evidence to assess the situation is perhaps a better strategy in this current highly volatile environment. We remain with our cautious view near-term, but would continue to look for opportunities to move gradually back to risky assets with much more attractive valuation.
Author: Schroders Asia Multi-Asset Team