Spreads on global high-yield bonds fell by some 110-120 basis points, meaning bond prices had a very decent appreciation in April.
And that's but one month – in the midst of the worst economic and financial crisis the world has seen in decades, likely to hit global GDP much harder than the great financial crisis.
Admittedly, it didn't come close to erasing all of this year's losses. And, of course, it may be a temporary bounce, a typical reaction to an overreaction in March. I do believe, though, that there is more to this story.
In response to the crisis, governments and central banks around the globe took a number of measures to counteract what many, including our own government, would label market failure. A Federal Reserve press release introduced actions taken to promote/support "the smooth functioning of markets"; i.e. markets didn't function like they should. Incidentally, Investopedia just updated its market failure entry.
The Econ 1.01 lesson is that when markets fail, governments step in, trying/hoping to correct or ameliorate the failure. There might, however, be an additonal Finance lesson here.
Malfunction in capital markets does not lead to artificially elevated prices on securities or commodities. We don't need to discuss that possibility, do we? If there is some kind of market failure, the impact is certainly negative; we can expect it to depress prices – like it did this spring. In fact, we can expect it to depress prices below their "natural" level in the absence of market failure – because the failure is in the very market that does the job of setting the prices.
April provided a vivid indication that prices had indeed been artificially depressed. Admittedly, we don't know the extent of the coronavirus crisis going forward. The optimists may still be proven fatally wrong. When you think about it, though, that is not tantamount to saying that the markets were right in March. We now know more than we knew a month ago and capital markets are decidedly firmer. They also function better, with fewer hiccups.
In part, then, government intervention did have the intended impact. It often does. Therein lies the clue of the month: When governments do feel the need to intervene, especially if they decide to intervene on a grand scale, it may just be an unfortunate time to sell.
Finn Øystein Bergh
Chief Economist & Strategist
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