Market plumbing likely to remain under pressure - Capital Economics
Global Markets

Market plumbing likely to remain under pressure

DM Markets Chart Book
Written by Jonas Goltermann
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Although we think that continued support from policymakers will prevent a financial system meltdown that would amplify the economic shock from the coronavirus pandemic, tensions in markets are likely to remain significant until there are signs that the measures to contain the virus are working.

  • Although we think that continued support from policymakers will prevent a financial system meltdown that would amplify the economic shock from the coronavirus pandemic, tensions in markets are likely to remain significant until there are signs that the measures to contain the virus are working.
  • The turmoil in markets over the past month as the coronavirus pandemic has spread across the world has led to sharp falls in the prices of risky assets and triggered some of the worst strains in the financial system since the 2007-09 Global Financial Crisis (GFC). (See Chart 1.) While the strains are not as acute as they were then, that is little comfort: the GFC is an extreme benchmark, and post-crisis policies have remade the architecture of the financial system precisely with the intention of avoiding a repeat.
  • We track a range of indicators of the health of global markets, which all point to mounting stress despite the recent bounce in equity prices. Central banks’ efforts to support their economies and shore up the financial system have so far only partially alleviated these tensions. Further measures may be required to keep markets afloat through the pandemic.
  • This note is split into four sections:
  • Money markets are under the worst strain since the GFC.
  • Market liquidity is impaired, with many markets showing significant dislocation.
  • Bank equities have fallen sharply, and CDS premia on bank debt have risen.
  • The perceived risk of sovereign default has increased, especially in emerging markets and Italy.
  • This is a new publication that takes stock of the various signs of stress across the global financial system. We intend to update the analysis periodically while the current market turmoil continues.

Chart 1: S&P 500 & 3-Month USD Libor – OIS Spread

Sources: Refinitiv, Capital Economics

Money Markets

  • The coronavirus pandemic has triggered some of the worst stress in global money markets since the 2007-09 financial crisis. The difference between secured and unsecured lending rates for US dollars in the interbank market has risen to its highest level since 2009 (2), though it remains well below its crisis-era peak. Similarly, the difference between 3-month repo and T-bill rates has jumped (3).
  • Cross-currency basis swaps (which measure the additional cost to non-US borrowers of obtaining dollar funding) have also spiked. The basis in euro, yen, and sterling widened to where it was during the euro-zone crisis, though still some way from the levels seen in 2007-09 (4). The Fed’s decision to reactivate and expand its swap lines with other major central banks (which allow non-US banks to access dollars through their home central bank) has eased these strains, although the yen basis remains elevated (5).
  • Funding markets for corporates are also under strain. In the US, the interest rate on 3-month commercial paper is higher than at any time since 2009 (6), and the spread on longer-dated corporate bonds has also jumped (7). In Europe and Japan, they have risen by less, in part thanks to greater central bank support. The Fed’s announcement of large-scale support for corporate funding has had limited impact so far.

Chart 2: 3M LIBOR – OIS Spread (bp)

Chart 3: USD 3M Repo Rate – 3M T-Bill Yield (bp)

Chart 4: Selected Basis Swaps to USD (Inv., bp)

Chart 5: Selected Basis Swaps to USD In 2020 (Inv., bp,)

Chart 6: Selected Yield Spreads of 3M Commercial Paper Over 3M Government Bonds (bp)

Chart 7: Investment-Grade Corporate Bond
Option-Adjusted Spreads (bp)

Sources: Refinitiv, Bloomberg, Capital Economics

Market Liquidity

  • The sharp moves across most markets appear to have caused significant fire sales of liquid assets as investors scrambled for safety and were forced to meet margin calls and redemption demands. As the turmoil intensified over the past couple of weeks, the price of assets that normally act as safe havens when risk sentiment sours – such as gold and government bonds – fell in tandem with those of risky assets (8).
  • The bid-ask spread in bond markets has widened markedly over the past couple of weeks (9), which has led to significant discrepancies between the market prices of bond ETFs and their net asset values (10). There are also significant dislocations in the market for US Treasury bonds, with those of similar maturities trading at different yields (11). This suggests that market participants who would normally arbitrage away such discrepancies are unable to do so. The bid-ask spread in the gold market has widened as well (12).
  • FX markets, where daily turnover dwarfs even that in government bond markets, have also seen large swings over recent weeks, in part because liquidity has become scarce even there. Implied volatility in FX options – a measure of expected future price changes – has risen sharply (13).

Chart 8: Week-On-Week Change In Price Of
Equities & Safe Assets (%)

Chart 9: Bid & Ask Yield Of 2.375% 03/22 Treasury
in 2020 (%)

Chart 10: Market Price & Net Asset Value Per Share of Vanguard Total Bond Market ETF (US$)

Chart 11: Yield Of 2.375% 03/22 Treasury Less Yield
Of 1.75% 02/22 Treasury (bp)

Chart 12: Gold Bid & Ask Price (US Dollars Per Ounce)

Chart 13: Implied Volatility Of At-The-Money 1-Year FX Options (Vs US Dollar, %)

Sources: Refinitiv, Capital Economics


  • The banking sector has been among the hardest hit by the equity market plunge (14 & 15). In Europe and the US, banks have lost around 40% of their market value in just over a month. As a result, the price-to-book ratio of the major banks has dropped sharply (16). That reflects both the risk of credit losses and the expectation that interest rates will stay ultra-low for a prolonged period, undermining banks’ profitability.
  • The cost of insurance against default on senior bank debt has risen sharply over the past couple of weeks, but it remains a long way below the levels seen in 2007-09 or in 2011-12 during the euro-zone crisis (17). Credit default swap premia have risen furthest in Italy (18 & 19), which has been the worst hit by the pandemic and where bank balance sheets were already weaker than elsewhere.
  • While much of this mirrors what happened in 2007-09 and 2011-12, bank balance sheets are more robust now than they were then, which has probably helped limit the rise in perceived default risk. Perhaps more importantly, policymakers have been unequivocal that they will stand behind their banking systems, in order to prevent a credit freeze from amplifying the pandemic shock and triggering another financial crisis.

Chart 14: Bank Equity Indices In 2020 (19th Feb. = 100)

Chart 15: Ratio Of Banks Equity Index
To Overall Equity Index In 2020

Chart 16: Banks Price-To-Book Ratios By Region

Chart 17: 5-Year Credit Default Swap Premia On Senior Bank Debt By Region (bp)

Chart 18: 5-Year Credit Default Swap Premia On Senior Bank Debt By Region In 2020 (bp)

Chart 19: 5-Year Credit Default Swap Premia On Senior Bank Debt In 2020 (bp)

Sources: Refinitiv, Capital Economics


  • The pandemic has also raised the spectre of sovereign default. Even the safest of government issuers have seen their CDS premia rise, although they remain at very low levels (20 & 21). Outright default by countries that issue debt in their own currency is very unlikely given that, in extremis, they can rely on their central banks to fund their debt – indeed, the dramatic expansion of QE is a step in that direction.
  • The euro-zone countries, on the other hand, do not necessarily have that option, given that the ECB is controlled by the member states jointly. The CDS premia of Italy and Spain have jumped to their highest level since the aftermath of the 2011-12 euro-zone crisis (22 & 23). Italy, in particular, is a concern, since its government finances were already fragile, and it has been the hardest hit by the pandemic.
  • In emerging markets, perceived default risk for many issuers has risen sharply as well (24), leading to a rise in the yields of their government debt – both dollar-denominated (25) and local currency. The rise has been largest for countries that rely on commodity exports and/or already had weak balance sheets. In contrast, China has been a relative safe haven, probably thanks to its large foreign exchange reserves.

Chart 20: 5-Year Credit Default Swap Premia
In “Low-Risk” DMs (bp)

Chart 21: 5-Year Credit Default Swap Premia
In “Low-Risk” DMs (bp) In 2020

Chart 22: 5-Year Credit Default Premia
In Selected Euro-zone Countries (bp)

Chart 23: 5-Year Credit Default Swap Premia In Selected
Euro-zone Countries In 2020 (bp)

Chart 24: 5-Year Credit Default Swap Premia For Selected EMs

Chart 25: EMBI Yields For Selected EMs (%)

Sources: Refinitiv, Capital Economics

Jonas Goltermann, Senior Markets Economist,
Franziska Palmas, Assistant Economist,


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