CIO Strategy Flash: “Fire sales” in Financial Markets?
The equity selloff extended further this week and over the past few days, with US Treasury yields also rising rapidly. Market anticipation of a huge US fiscal stimulus could be one of the reasons that long-end yields rise, while there is also some market attention on the massive unwinding of equity and bond positions by the leveraged systematic strategies, such as CTA and Risk Parity Funds.
CTA are typically algorithm based fund managers, where the initial sell off generated massive sell signals for their equity and bond positions.
Risk parity funds suffered as traditional correlation between equities and fixed income (which typically cushions losses between cross-asset) broke down. This causes massive deleveraging on both equities and fixed income.
The chart below shows that the systematic equity positioning reversed very sharply compared to discretionary investors i.e. active mutual funds, institutional and individual investors etc.
Source: EPFR, Bloomberg, Haver, Deutsche Bank, as of 13 Mar 2020
This chart also indicates that CTA’s exposure to USD 10-year Treasuries has been reducing significantly recently.
Source: Bloomberg, SG, JPMorgan, as of 19 Mar 2020 Note: Model is a 1-month regression of daily excess returns on the CTA index versus daily excess returns on 1) J.P. Morgan US 7-10Y bond index, 2) J.P. Morgan ex-US Global Bond Index, 3) S&P500 index, 4) J.P. Morgan global cash index, and 5) Goldman Sachs Commodities Index
The Fed and other central banks recognized the liquidity issues and have been intensifying measures to support the market. Governments around the world also kick started fiscal stimulus to offset the negative impact from economic disruptions due to the COVID pandemic.
Central banks and governments are getting to “whatever it takes” to rescue the world from the health crisis.