Surveillance: We're Headed For a Recession, Wilson Says

with us. Let's just reflect on what the fattest to live and what's still to come through the next couple of weeks. Your thoughts please, well, I think really yeah, we can see by the reaction of the markets this morning,

and I don't think that there is enough. And really, as long as this news remains such that we keep on getting an increase in the number of coronaviruses, and both the Europe and the US at the market is going to assume that the real economy, or the out of the real economy is going to get to carry on worse need and therefore um that the central banks are going to have to do more monitor fiscal policy too.

Of course, a lot more is gonna have to come from there, but I think one thing that that was in particular missing perhaps from from the FEDS announcement, and this was the concerted in the concerted action that was announced yesterday was coordinated with DCB, and like the japan and the b o E and the SMB. Now these are all G ten central banks, and we've had new cheaper swap line provisions for the for the for the G ten. But there are going to be concerns about

corporates outside of the GTN area. What's going to happen with them? What if they cannot get a hold of dollars. We've seen since the middle of last week really that the blowout in in in cross country basis what for

instances of the pressure in the money market. And of course, if we go back to two thousand and eight, we saw the FED announced other emergency measures a commercial paper funding facility and then the commercial paper funding facilities through the limited company that was that was set up to provide um for facility whereby companies outside of the detail could could sell to the Federal Bank of New York

commercial paper and get all liquidity that way. And I think the market will be demanding that the fedders something extra like in two thousand and next to really reassure the markets that there is going to be ampled on the liquidity in and at least that way it will be one thing less I think for many corporates to

worry about. Jane yesterday, around five pm Eastern time, when we got the response from the federals or of the Hunter basis point rate cut, the futures markets for US equities weren't open yet, and we looked for the to get some kind of initial read on the market response. At the currency markets, and they've been going crazy, the OSSI dollar in particular, really sinking to a post crisis low. And I'm trying to understand the volatility that we're seeing.

Is this just a complete vacuum of information, or is this a structural issue that's affecting all markets for some reason and creating a real dearth of liquidity that's potentially really problematic. Um well, I think perhaps there's there's a number of factors. I think first of all, you know, looking at looking at the AUSSI, looking at some other currencies.

What we see here is is dollar strength. So there is a scramble really to get hold of dollars, and this is because, of course the dollar dominates the global payment system and people need dollars. But I think apart from that, I think the other signals that we're getting is is that the type of crisis that we have here and now, the type of crisis. Of course, it's not a financial crisis. It is something to do with

the real economy. And yes, loans might be cheaper, but if you are an airline, or if you're in the tourism industry, or if you're a certain type of retailer, et cetera, it doesn't mean to say that you're going to have customers coming through your door this morning. And so from that point of view, we can really see the the the shortfalls. Really a monetary policy, it cannot put demand back into the shops given the type of crisis that we have, so monetary polar see just has

its limits. And therefore, you know, we do need this fiscal type of support, maybe are concerted type of fiscal response to try and reshort, reassure the firms that are most acutely affected by this that their businesses can sustain through this crisis and that they won't lose all of their employees because immediately if you lose all your employees,

you have this knock on effect. You have this multiplier effect with those people who lose their jobs and they don't go to the shops and they don't they don't buy, and you suddenly have this potential for this really sharp down or shops slow down in in activity jam. We can't handicap this deep into the unknown, impossible to model. Most of the people listening to this program will agree

with you on all of those things. Where we can have a discussion is how you think the dollar will behave in the environment like the one we're about to enter. There were doubts when times were good over the last couple of years about what would happen in the next downturn and how the dollar would behave. Would it maintain those risthma againing characteristics? Would we buy the dollar when things got bad? Can we say with some confidence that that's still the case, The dollar will still be that

currency people flee to. Yes, I would agree with that, and I would go a bit further, and I'd say that the market has no choice but to buy the dollars. If you think about the dollars position as a as a global transactional currency, no other currency comes close. It's plain and simple. If you are in India and you need to buy oil, you need to have dollars. If you need to buy all with any other commodities, you

need to have dollars. And this is why if you look now at the money market, if you look at a cross cluncy basis what you will see that they blew out in the middle of of of last week. And this is the sign that that banks were willing

to pay more to get hold of their dollars. Corporates are potentially right now looking around making sure that they have access to dollars through their banks, through their funding lines um and banks are looking to see, oh my goodness, how many of these funding knowes do we have open? What what could be the potential at draw down of dollars from US So dollars in a in a crisis

is where the shortages usually are. And the fact that we have these signs really sin at the beginning of since the middle really of last week, of the blowout

in demand for dollars is where the crisis is. Well. Jane, thinking about how that's reflected in the price of G ten right now, quite clearly there will be some exceptions to that dollar strength roll the Japanese yen and the Swiss frank too, where people have really been punished and it's been brutal to try and get a clear direction on euro dollar over the last month meant to be some real equidity there, some depth, and it's been really

really choppy. At one point it was about just trading the possibility, the potential that Europe would go into a downturn. That was the standard February. Then it was about unwinding some big, big traits going back home to the Euro of that which your funding currency. You're a bit up towards one fifteen and now negative again in and around those kind of levels. Jane, walk me through the dynamics

that are going to shape the Euro in the coming months. Well, I think really the the euro, the euro dollar exchange, it has probably misled a few people in terms of dollar strength. I think if you if you look broad based, if you look through a huge range of currencies, you will see the dollar strengths there and that the Euro has given misleading signal. And I think this is because

of what you've just described. There were the the euro with the negative interest rate had been used as a funding currency, and they of course reversed and people cover their shorts and the euro went higher. But I think if we look at what we have in Europe now in terms of fundamentals, I don't think they're particularly good for Europe. So, for instance, UM, if you look at Italy,

and clearly the coronavirus situation in Italy is extremely worrying. There, without a shadow of a doubt, given that the countries in in shutdown, and given that there there is no sign yet that those cases have peaked, the economic backdrop can be worrying. People will be starting to worry already worrying about the Italian banks. For instance. If we move on to Spain, the situation there's worse than UM. If we go through France and they in the situation, that

also worsening. So we can pick out a number of European countries and we see fundamentals getting getting worse. So from that point of view, UM, I don't think the euro has got an awful lot about it right now. So given that the dollar is being brought broadly because it is a global payment system currency, I do think

that your a dollar can slip. However, I think if you want to see where the dollar strength is, you should look away from your a dollar and you should look at a broad basket of currencies, and that's where you see the dollar strength. Jane got to catch up here this morning. I appreciate your time. Jane Foley, their Rabbit bankhead of FX strategy, went in on the Fett decision and on global currency markets. Credit very much in the driving seat at the moment. Let's bring in Mike Wilson,

shall wait a guiding light for times like this. The team at Morgan Stanley, the chief US equity strategist, joined us on the phone. Now, Mike, fantastic to have you with us. Your cool, your message to your clients on the morning like this morning. Well, look, first of all, the panic is, you know, happening in financial markets, and

I think for good reason. I mean, there's a health crisis and it's scared, and I think I want to just first start by saying, we're talking about financial markets, but you know, there is a health issue, so we just want to make sure we're sensitive to that in all of our commentary because it is a personal tragedy in some cases. So let's let's focus on you know, what the markets have already been telling us for quite

a while. And we think this is uh kind of where our view might be a little bit different than others, is that we think we were heading towards kind of a recession. Anyways. We clearly had no idea virus or you know, an oil price shock was going to be

the final kind of thing that tips us over. But there's always something, and so now we are heading towards a recession, probably globally US as well, and in the markets are quickly discounting that from a from a period by the way, when none of that was being discounted, you know, several months ago, so that it's just been that's why been so violent, and we're getting to some very interesting price levels for for assets that you know, for longer term investors are attractive and we will get

through this. Uh, you know, we think that. You know, obviously the actions last night, you know, people are disappointed perhaps that the FED can do it, but the reality is that FED can't do anything about the virus, right, so they're going to do what they can, which has provide liquidity to markets that they function. And then when we can get past this and look forward again, to the recovery, then you know, liquidy will be in place,

and then we can stabilize and move forward. So this is the time for clients to not do anything rash, right, It's not a time for for people to sell everything and panic. We've we've already had that client in a straight line, and so that's pretty much a waterfall decline. Uh. To have another waterfall decline on top of that would be historically unprecedented. Even in the you know, the twenties and thirties or areas like that usually get some relief. Okay,

so we are expecting that at some point. The two things I'm focused on right now, UH, to tell me that maybe the worst is getting behind us is the treasury market, which has been the guiding light to tell us all along that growth was continuing to slow. And I think it's interesting. That's not it's not a guarantee, but it's interesting. The treasury yields are not making new loads, uh, and did not make new loads last week either, and later in the week when things really kind of came apart.

So I think that's important. UM. I will continue to watch. That will also tell me that the treasury markets functioning, which is important, and that's the FEDS concern in this hue. But we're gonna need more fiscal and I think so that's the other thing I'm really watching is how more how much more aggressive can politicians get in the short term to uh, you know, to indicate that they are going to do more fiscal policy because monetary can't do

this on its own. So last week you told myself from John and Tom that this was a time to start adding back risk that this is actually potentially a buying opportunity. Goldman sachs Is David Couston came out over the weekend with reports saying that the SMP five hundred could fall another twenty six percent from Friday's closed to two thousand if the economic fallout from the coronavirus deepens. Why do you not think that's the case. Well, that's

always a possibility. Of course, it's a possibility, right, But you know, we think that this has been I think where we're a little different perhaps in some others, is it we think this correction that we're going through right now is part of a bear market that began two years ago, right, And if you're if you're really objective about what's been going on the average stock and the average market has really gone nowhere for two years. And this is kind of a finishing move. It's ending in

the recession. That's the way it typically works. Now we have to we have to get into that recession and people have to acknowledge that. But if you can't tell me that, you know, markets haven't been discounting a pretty meaningful slowdown now for the past couple of years. That's why we've been trading very defensively. That's why treasuries are already you know, at record low levels, even before the

virus hit and before the oil price. The clients, I mean, we've we've had signals all along, and so all we're telling folkuses is that this is how things, this is how moves kind of finish. Okay, the time to get really defensive was two years ago, uh, in terms of like being overweight treasuries, being overweight defensive areas and whatnot, and and those types of strategies have worked extraordinarily well

over the last two years. And so now if you were set up that way, now is the time to start thinking about re risking, understanding that it's going to be extraordinarily volatile in the next month or two is going to be extraordinarily whippy. It's gonna be extraordinarily dangerous to be trading this okay if I were advising people to do. But if you're in a diversified portfolio and you've had some defensive securities, you've probably actually done okay

over this period. Mike, really thoughtful stuff. I appreciate your time this morning and wishing the best to your team. And those are Morgan Stanley as well. Mike Wilson. There, Morgan Stanley, Chief US Equity Strategists. You hope some trade in the equity are gonna used to be funded bunder bond investor. No more. This is about protecting ratings and

meeting coupon payments. And we'll get to that right now, and we can do it with Goes and Distant found a b CO head of fixed income Goes and fantastic to have you with us on the phone. Let's start there. Default risk. Let's just start with something extreme, the extreme tale. It was talked to me about default risk at a moment like this. Well, look, I think we are an unprecedented times. John. You know we've we've spent the past decade plus talking about how the next downturn is not

going to be a two thousand and eight. Al Right, we keep on especially cautioning, you know, younger investors that don't remember the last recession before two thousand and eight, right, don't remember all one on two, and the next downturn is not going to be two thousand and eight. The reality is that you know, well, of course it's not going to be a two thousand and eight. The impact could very well be two dozen and eight if we

don't get a response on the fiscal side. You know, the the for certain industries, the economy is essentially shutting down, and that is, if we don't get the proper response on the fiscal side, we will see the faults in certain sectors spike. This is exactly what fixed what credit

investors worry about. We worry about that left tail. We worry about over levered companies, right for whatever reason, their business their top line being shut down, not being able to generate free cash flow to be able to meet their debt obligations, and that is going to be an increasing concern, and that's why you've seen a lot of stress in the credit markets over the past couple of weeks, guess, and this quote came from making over a city group.

He right the following. With so much credit provided outside the banking system, it's very difficult to implement a system wide payments freeze which ensures all obligations are simply rolled over. The consequent timing of conditions has a tendency to cascade through the rest of the system. This is an important point. I've been beating the drum with you, guess, and we need a fiscal response, and we need to quick. But there's going to be limits on how much this can cover.

But look, I think, look, we're seeing who knows what the fiscal response is going to be, but we are seeing a lot of interesting proposals being floated out there. Um, you know, the easy one is helicopter money, Right, we just write a check to everybody. The problem with that is it ends up not being targeted to the places that I mean. It helps the consumer obviously, and there's a lot of value to that. We're seeing some unconventional proposals.

You know, maybe you start saying the government should be the buyer of last resort, should prop up certain industries, should you know, basically guarantee that airlines fill seats and if they don't, they the government hands them the revenue. Um. There's other kinds of proposals that are being floated around there. You know, it's it's it's gonna take some creative thinking and it's going to have to happen fast, because what we're seeing right now is I heard you say it earlier,

John fear is taking over. Um. We are shutting down large segments of the economy, and it's going to have to be a fiscal response. It's great that monetary policy is doing what they can, and they're supposed to do what they can, but this is not a demand problem. This is the supply problem, and it requires a different response. Grishan, we're talking about credit, and we should just say there is sort of a dual shock here too, at the oil complex in particular getting hit as oil prices decline,

and I'm wondering though the technical action. I want to go from the fundamental to the technical picture. E t fs in particular saw unprecedented outflows in the past few weeks, and people are worried about a spiral that these that these e t f s are being traded frequently for liquidity and that as their prices go down, they have to sell underlying assets. The sales end up driving prices down even further and the cycle goes. How close are

we to that? You know, it's interesting we're seeing that in the E t F. I will counter that we're not seeing yet is in fun flows, which is an interesting dichotomy. You know, past sell offs of this, even of lesser magnitude, and this we saw much more panic from the end investor in mutual funds, both in the US and offshore. And I'm not saying we're not seeing any apples, of course we are, but it's not of the magnitude we saw previously. And I think that's interesting. Um,

it's been, it's it's been kind of orderly. And if you look at you know, one of my favorite topics, Lisa, is the relationship between high yield and equities. And you know, with equities being down, you know, they were down I guess percent from the peak with the rally back on on Friday, I gets down twenty two or something like that, and we'll probably back down and we open. You know, hi yields down about twelve percent from the peak, roughly half.

That's typically what you see, so the price actually indicates that it's somewhat orderly there. Actually, even before the rally on Friday, liquidity was okay in the high yield market, stuff was down, So it's it's becoming orderly. You know, at some point, if the outflows are are sufficient, whether it's from ETFs or it's from kind of real money mutual funds, that could cause a problem in liquidity. And

that's something that we're looking at very carefully. You know, the fact that it was difficult to sell off the run treasury back on Thursday, something that wasn't the case even in the worst time of oh eight is something that is concerning to us and should be concerning to most market participants, guess. And let's talk about that and what the Fed can do to have alleviate some of that stress. Right now? What can they do it? They're

doing enough. I look at that they've they've done, you know, they've announced two things since that happened on Thursday, and that's the question. We'll see, we'll see what happens today. Um, they're doing everything they can. They're they're opening up the window, they're buying, they're buying back treasuries across the curve that has helped. Uh. But that's that's the danger of the market when you when even the thing that's supposed to be the most liquid market in the world is experiencing

liquidity issues. UH. That should raise concerns and there might have to be more action that has to be taken. Guess you don't want to finish with just a quick word on portfile a construction, and I'll try and keep this as simple as possible for the majority of our

audience that may not be moll straight professionals. You've always compared for me, at least when we've talked historically speaking about how credit performs in a downturn as part of a portfolio, and how equity performs in that downturn too. Walk me through that historically and how you think that may or may not be the same this time around. Yes, so, historically equities and credit perform in they go in the

same direction. They're highly correlated. In other words, when equities do well, credit does well, and when equities do poorly, credit does poor. The accepted magnetitude is different. So for example, last year, when equity has had a very strong return depending on what type of equities, how did ten or fifteen, depending what type of high yield and in the cell off here, as I mentioned before, the Lisa equities have been down hids going down ten. That relationship should continue.

Now if if the worst happens and we massive spike in defaults, maybe credit does a little bit worse on that on that score, but that relationship holds pretty pretty well. The one nice thing about credit, especially how yield credit is your yield is actually a very good predictor of your intermediate term performance. If you chart your yield to worst at a given time and in the next five years annualized return, it's almost spooky how accurate that is.

So if you take today's starting yield of somewhere in like the eight eight and a half percent range, that is likely through through all the volatility we're gonna see. If you invest today, you're likely to get somewhere around an eight percent annualized return over the next five years. There'll be a lot of volatility in between. Imagine a lot of that volatility is coming up front. Gus and

fantastic to catch up and the gush and distance. Found that a VC had a fixed income on the credit market, not just in the US for some of these worldwide issues as well. Joining us on the phone stay thing that the standard child at bank managing direct it's way and on foreign exchange stave, we have some dollar weakness.

Is it fair to say that dollar awaitness has been engineered by a major right cut at the FED, a major rate cut by the Fed, and the major change and expectations I think in the market with respect to where rate differentials are going to be over the medium and long term. I think that the with this move, the market is convinced that, you know, we're not good to see, uh, the US rates really having nearly as big a great advantage as they have had over the

last couple of years going forward. How important is it this sort of dollar swap line that the Federal Reserve set up? I mean, how much will that cushion the blow that we've seen just in terms of the bid for dollars and some of the liquidity issues of last week? You know, I look at it's not going to fix anything in the sense that it won't improve the economic outcomes, but it will prevent um financial market outcomes from making

things worse. Um. You know, so far, what we've seen is some of the basis risks come in a little bit, not very much. I think the markets will test the willingness of central banks to use these lines and use them in large size before they're convinced that they don't have to worry about it. Steve, I want to bring up something that I think is becoming a little bit delicate,

and it's over in Europe. I don't think we're back onto the redenomination risk junior out of the bottle story, but I do think we've got a story over in Italy where the ECB really failed last Thursday in that news conference to do anything about burning up confidence on the periphery. The two year yields up eighteen basis points on the session, albeit was still seth of one percent. But the direction of travel, Steve, is not encouraging. Do we start to think about some of these issues. Do

they creep back into the discussion. Well, if they do, they're going to make things a lot worse, because you know, we have enough risk premium in the market already to add more because of political risk um, it would be doing unnecessary damage. I think that the expectation and hope is that they're going to finally throw in the towel and say this is such a crisis that each country should do what it has to do on the fiscal side.

Um and the ECB, you know, continue to do what it what it has been doing on on the monetary side. I don't think leguard really meant to serve dismiss the spread issues. I think it just came out something wrong Stephen. There's also a question going forward, at what point will currency markets care about the money printing that developed markets seemed to be on the cusp of doing. That might be unprecedented in side. Certainly people are saying it should be,

whether it's helicopter money or anything else. There was a time when that used to debase the currency. Is that time over or are we going to return to a time where that actually starts to matter. I think eventually there's going to be a debate if this for a long time. I think correctly the market is thinking that if we're talking about a three or six month period in which production is impaired, even if it's sharply impaired, the demand risk and the disinflationary risk is more important

than the money printing risk. If this is a longer term question where supply is impaired over a period of years, and they print money and train maintain demand, the inflation

outcomes may be different. Steve tried to cash out with you this morning, Steve England, and there standard charted on a really delicate moment wildwide on the issue of the e c B and President of Guards performance last Thursday, reportedly in the Financial Times apologizing to several members of the Governing Council for some of the mistakes she made

in that particular news conference. Now I'm not sure, in fact, I know on the record that the ECB is not characterizing the performance on Thursday as a mistake, but according to the Financial Times, it appears she did apologize to a government Council members. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at

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