Flash Money Market – post PEPP*

23/03/2020

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Without being able to reassure the markets definitively, governments and central banks have been stepping up their interventions over the past few days to help companies and banks cope with the brutal global economic deterioration.

Key points

  •  Without being able to reassure the markets definitively, governments and central banks have been stepping up their interventions over the past few days to help companies and banks cope with the brutal global economic deterioration.
  • The intervention on Wednesday evening by Christine Lagarde, the President of the European Central Bank (ECB), is likely to reassure market participants on the liquidity of the European banking system and on the continued granting of credits to companies.
  • We naturally continue to actively monitor and manage liquidity, the cornerstone of our investment philosophy, in our short-term Money Market portfolios (Groupama Entreprises) and our classical Money Market portfolios (Groupama Monétaire and Groupama Trésorerie).

 

Central Banks flex their muscles: historically accommodative monetary environment

 They promised to be reactive in case of shock, they were!

The Central Banks have intervened several times in recent weeks, during their traditional meetings but also during inter-meetings. They have thus shown that they take seriously the prospect of a generalized containment following the rapid spread of the coronavirus outside the Chinese borders.

Through the measures implemented in the wake of their intervention, they aim first and foremost not to add a financial crisis to the health and economic crises we are going through.

 Accommodative bias in all directions

In concrete terms, dozens of Central Banks have cut their key rates.

Apart from the Chinese Central Bank (PBoC), it was the US Federal Reserve (Fed) that was the promptest in cutting these rates in two episodes by 150 basis points (on 3 and 15 March).

The rapid use of the Fed’s conventional toolbox (lowering the key rate) was certainly not well received by the markets, which saw it more as panic than as appropriate support for American companies. That being said, the Fed completed its arsenal of conciliatory measures by supporting the inter-banking market and ensuring liquidity by launching a new $700 billion quantitative easing (“QE”) program for 2020.

Lastly, the Central Banks were able to coordinate their efforts by agreeing to swap dollar-denominated liquidities among themselves at reduced cost, sometimes without any ceiling on the amount.

 

ECB in less of a hurry than its counterparts

 The ECB waited for its traditional meeting on March 12 to unveil its measures to tackle the economic slowdown. It was above all a battery of measures in favour of the banking sector:

1.  Additional liquidity injections

2. QE

3.  No further cut in the deposit rate

4.  Regulatory loosening

 

1.  Additional liquidity injections

· Launch of LTROs (Long Term Refinancing Operations) on favourable, temporary and immediate terms to support the liquidity of the euro area financial system. The first LTRO under these new conditions took place this week and was very successful (EUR 109 billion of liquidity requests).

· Several TLTROs at even more favourable conditions than previously announced will be held from June. The ECB is committed to inject longer term liquidity (TLTRO – Targeted Long-Term Refinancing Operations) at even more favourable conditions: banks will be able to borrow at -0.75% and deposit their money at -0.50%. This is a risk-free investment with a return of 0.25%. In addition, the maximum amount that banks will be able to borrow during this TLTRO is increased to 50% of their outstanding eligible loans as at 28 February 2019. This measure is a strong support for the granting of loans to households and companies.

 2. QE: an increase in net asset buybacks of EUR 120 billion until the end of the year, on top of the EUR 240 billion previously announced last year-end. This time, the programme should focus on corporate bonds. These purchases are expected to continue beyond 2020 until the ECB considers raising its key rates.

 3. No further cut in the deposit rate to shun further pressure on bank margins.

 4.   Regulatory loosening. Until at least the end of the year, the requirements for complying with regulatory capital ratios are significantly eased. This will allow banks to operate temporarily below the minimum required level of capital. Freed from certain regulatory constraints, banks will be able to release capital to support the economy. There will also be no more stress tests on euro area banks this year.

 

All these measures constitute a true support for the banking sector, which is an essential component of a well-functioning money market.

 

Extended Quantitative Easing: the ECB is arming itself with the PEPP

 After a clear support to the banking sector on March 12, the ECB chose to reassure on market liquidity on Wednesday evening March 18 with surprise announcements.

It said it was launching an additional €750 billion quantitative easing program, the Pandemic Emergency Purchase Program (PEPP), which by the end of the year will weigh about six times more than the program announced last week (€120 billion).

In total, the €1000 billion of buybacks should be exceeded by the end of the year, as never before.

Should the crisis continue, the ECB has made it clear that the PEPP will continue, giving it a potentially unlimited character.

QEs by the ECB (by kind of assets, by year, in bn of euros)

*estimate. Source: Bloomberg. Data at end February 2020

 

The objective of the ECB is to provide explicit support this time to governments, especially peripheral governments (Greece is even eligible to the PEPP), and to companies.

 It is also a direct and strong support for money market liquidity, since eligible assets include money market instruments (commercial paper issued by companies).

The ECB is thus following in the footsteps of the Fed, the Bank of Japan and the Bank of England in its commitment to support the smooth running of the money markets.

 

A strong and concerted government response: waiting for a ghost….

 Finally, Christine Lagarde did not wait for a concerted and single response from the political representatives of the euro zone to deliver her package of measures. However, governments are deploying measures separately and to fluctuating grades (guaranteed loans, deferral of charges/taxes, budget stimulus) that are likely to provide a bubble of oxygen for companies that find themselves in financial trouble.

 Many of these measures ensure the solvency of companies.

 

Activity in our money market portfolios: focus on liquidity

 Increase in WAM** since the beginning of the year, caution on WAL**

In an environment of ultra-accommodative monetary policy on the part of the Central Banks, and the ECB in particular, we maintain a relatively high rate duration (WAM) for our money market funds. This made it possible to offset the spread widening observed in the first half of March.

On the other hand, we are cautious on credit duration (WAL) in relation to our authorised range in an environment where corporate debt spreads are very volatile.

In days (current level / limit)

Data as of March 19, 2020. Source: Groupama Asset Management. Groupama Entreprises belongs to the Short Term Money Market category, Groupama Monétaire and Groupama Trésorerie belong to the Classic Money Market category

 The liquidity of our portfolios remains strong with assets that can be traded at any time (bank deposits, money market funds). 

The combination of unfavourable events (extreme risk aversion, forced sales by institutional players to regain liquidity and the end of quarter changeover for banks) may have led to price declines on certain monetary instruments at the beginning of the week. However, we are still able to find prices in the market.

The actions taken and to be taken by the ECB reassure us that liquidity will remain in our money market funds.

Furthermore, neither monetary fund management nor Risk Department of Groupama Asset Management has identified any specific risk on our issuers and issues in the portfolio to date.

Finally, Groupama Asset Management conducts an in-depth analysis of portfolio liabilities with both a stress test of liabilities on a historical basis and the detection of customer patterns. These measures enable us to better anticipate future redemptions and subscriptions.

 Outlook: we expect a drastic reduction in spreads for assets under administration by the ECB in the long run

We continue to believe that the current market shock is brutal but transitory. We believe that opportunities on the credit side should be seized once the markets have calmed down, and not before. We will initially focus on the assets that will be administered by the ECB.

We are therefore taking a wait-and-see approach for the time being, focusing on the liquidity of our portfolios.

 

 As a reminder, the main risks associated with the funds mentioned are interest rate risk, credit risk, liquidity risk, risk of capital loss and derivative risk.

 

 * Pandemic Emergency Purchase Program : new 750 bn€ ECB QE program related to the coronavirus.

** WAM (Weighted Average Maturity): corresponds to the rate sensitivity expressed in days. WAL (Weighted Average Life): corresponds to the credit sensitivity expressed in days.

 

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Edited by Groupama Asset Management – Headquarters: 25 rue de la ville l’Evêque, 75008 Paris – Website: www.groupama-am.com