Views From the Floor

In this week’s edition: the US bailout package is big, but it may not be nearly big enough; and the death of central banking as we know it.

Quote of the Week:

"A successful central bank should be boring."

Mervyn King, 2000


My Fiscal Expansion’s Bigger Than Your Fiscal Expansion...

The news that the US Senate had approved fiscal stimulus legislation worth USD2 trillion has been greeted with elation in markets. This would represent roughly 9.4% of US GDP, which was about USD21 trillion in 2019.

However, it is worth putting that figure into context. Figure 1 shows the various fiscal stimuli proposed by governments globally, excluding the US. The value of the US direct stimulus package is, so far, the largest in the western world. However, as a percentage of GDP, it is smaller than that offered by other countries. Indeed, the European countries listed are currently offering liquidity provision in terms of loan guarantees, tax deferrals and moratoriums, which drive the total effect of all stimulus above 14% of GDP at the very least.

So, whilst the US bailout package is big, it may not be nearly big enough. The picture worsens further when we look at some projections for lost GDP growth – Goldman Sachs has projected as 24% annualised drop in GDP growth for the second quarter of 2020, with Morgan Stanley projecting 30%.

Figure 1. Coronavirus Fiscal Measures and Budget Impact

  Budget Spending Announced/Tracking (According to Government announcements and media reports) Change in Cyclical Component & One- Offs of Budget (According to Latest MS Research forecasts) Total Potential Budget Impact Government Estimate of Liquidity Provision supported by Loan Guarantees/Tax deferrals/Loan Moratoriums
  EUR/GBP billion % of GDP % of GDP % of GDP EUR billion (% of GDP)
Germany EUR122 billion (According to early reports on the spending compoenet of additional supplementary budget – part might be cyclical) 3.5% 1.6% 5.1% EUR100 billion (3%) of extra guarantes bringing the total to EUR 550 billion (16% of GDP)
France EUR45 billion 2.0% 1.1% 3.1% EUR330 billion (14% of GDP) in loan guarantees
Italy EUR26 billion 1.4% 2.0% 3.4% EUR340 billion (19%) is government estimate of total financing for economy leveraged by the latest package
Spain EUR21 billion 1.6% 2.0% 3.6% Around EUR200 billion (16%) is the government estimate of extra liquidity provided from loan moratorium, public guarantees and tax deferrals
UK GBP110 billion 5.5% 2.2% 7.7% GBP330 billion (15% of GDP)

Source: National Governments, Morgan Stanley Research; as of 23 March 2020.

From Liquidity Triage to Risk Taking

Remember the date: Monday 23 March, 2020; the day the Federal Reserve went from being a liquidity provider to a market participant, exposed to default risk for the first time.

In addition to its previous decision to purchase USD500 billion of US Treasuries and USD200 billion in mortgage-backed securities, the Fed’s announcement of 23 March also detailed the creation of three new facilities to purchase risk assets: the Primary Market Corporate Credit Facility (‘PMCCF’) to buy new bond and loan issuance; the Secondary Market Corporate Credit Facility (‘SMCCF’), responsible for ensuring liquidity for outstanding corporate bonds; and the Term Asset-Backed Securities Loan Facility (‘TALF’), to support the flow of credit to consumers and businesses. The activities of both the Money Market Mutual Fund Liquidity Facility (‘MMLF’) and the Commercial Paper Funding Facility (‘CPFF’) will be expanded. In addition to the steps above, the Fed is looking to establish a ‘Main Street Business Lending Program’ designed to offer credit to small-and-medium sized businesses. By moving its focus from risk-free assets such as Treasuries to corporate bonds, the Fed has made a historic change in its role and will make a gargantuan expansion to its balance sheet.

Contrast central banks’ response between the Great Financial Crisis and the Coronacrisis: in 2008, policy rates on a GDP-weighted basis came down 300 basis points. On the same basis, in 2020 only 55bp of rate cuts have been made. Despite their efforts, we are now in a world where the policy response needs to be fiscal because only governments can give people cash directly into pockets. The Fed’s decision to start participating in markets was, in effect, an attempt to form a halfway house between the two.

Don’t Blame the Quants

As markets tank, a knee-jerk response amongst some discretionary managers can be to blame it on trend-following CTAs. Markets fall, trend-following algorithms de-risk or go short, and a market move which may have initially been small becomes very, very large – or so the argument goes.

We don’t necessarily give credence to this idea at the best of times. And in the case of the coronavirus selloff, we believe it almost certainly isn’t true. As Figure 2 shows, CTA positioning has not been net short across all indices for similar amounts of time. Indeed, overall CTA positioning on the NASDAQ index only went short on 22 March, even though the index had been falling since 19 February.

Furthermore, it is not clear that trend-following funds have the required assets under management to have such an effect across equity markets. AUM in managed futures strategies as a percentage of total hedge fund AUM has fallen from around 28% in 1997 to only 8% in 2018 (Figure 3). More importantly, CTA futures volumes as a percentage of total futures trading volume is down from just above 7% in 2004 to less than 4% in 2018 (Figure 4).

Whatever technical factors are driving this market, in our view, it is highly unlikely that CTAs are it. In this case, managed futures funds have been trend-followers, not trend-setters.

Figure 2. CTA Positioning Across Indices

Market Position Days in Position Daily Month to Date Year to Date
  (gross returns)
Portfolio     2.42% 20.02% 9.17%
Equity Indices Short   -0.13% 1.97% -2.97%
S&P 500 E-Mini Short 8 0.08% -0.17% -0.55%
DJIA Mini Short 10 0.07% 0.53% 0.00%
Nikkei 225 Short 14 - 0.42% 0.02%
NASDAQ 100 Mini Short 2 0.07% -0.19% -0.16%
FTSE 100 Short 21 0.01% 0.48% -0.04%
Euro STOXX 50 Short 11 -0.05% 0.09% -0.34%
Hang Seng Short 22 -0.13% 0.32% 0.11%
DAX Short 11 -0.04% 0.13% -0.27%
CAC 40 Short 14 -0.08% 0.42% -0.03%
Russell 2000 Mini Short 11 0.04% 0.23% -0.35%
SPI 200 Short 10 0.01% 0.28% 0.18%
IBEX 35 Short 9 0.01% -0.05% -0.39%
KOSPI Short 8 -0.13% 0.03% -0.25%
Swedish OMX Short 7 0.03% -0.37% -0.57%
MIB Short 9 -0.03% -0.18% -0.33%

Source: Man GLG; as of 24 March 2020.

Source: Man Group database, BarclayHedge, FIA; as of 31 December 2018.
Note: CTA and hedge fund AUM have been derived from the BarclayHedge database, where Bridgewater AUM have been omitted from the CTA universe.

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Source: Man Group database, BarclayHedge and FIA; as of 31 December 2018.
Note: Based on the total number of listed futures contracts traded by CTAs.

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With contribution from: Ed Cole (Man GLG, Managing Director – Equities), Matthew Sargaison (Man AHL, CEO and co-CIO) and Graham Robertson (Man AHL, Head of Client Portfolio Management).