August 10, 2021 | Whitepaper

How fixed income markets responded to the pandemic

Nearly a year and a half has passed since the COVID-19 pandemic first swept the globe. While the markets have calmed and the global economy—despite ongoing public health challenges— continues to emerge from a short but severe recession, it's a good time to reflect on the pandemic's impact on the markets, particularly fixed income.

The "dash for cash"

Fixed income investors responded to the economic shock of the pandemic by rapidly selling assets to bolster their liquidity positions in a dash for cash. This broad divestment overwhelmed traditional channels, leading to a liquidity crunch and price dislocations across multiple fixed income sectors. Even the traditional safe haven of the U.S. Treasury markets experienced notable pressures. The volatility quickly spread to other fixed income sectors across the U.S. and Europe, including commercial paper, corporate bonds, variable-rate demand notes, mortgage-backed securities, and municipal bonds.

Causes of the liquidity crunch

Several factors influenced the strain on the fixed income markets. The general size and complexity of global fixed income markets, the magnitude of selling pressure in certain asset classes, dealers' willingness or ability to warehouse assets, and the evolution of fixed income market structure over time all contributed to the breakdown in dealer intermediation. Swift and comprehensive intervention by central banks and policymakers helped restore normal market functioning, with central banks acting as a key liquidity provider and market-maker of last resort.

What's to be done?

As our research points out, to reduce the likelihood of future intervention by central banks, any policy response should consider ways to enhance the market structure for U.S. Treasury securities, such as ensuring that policymakers have the data necessary to properly surveil the U.S. Treasury market, facilitate market functioning under stress, and inform future regulatory actions. Further, reforms that would foster continuous market-making and improved transparency should be considered. The market for U.S. Treasury securities is a vital part of our global fixed income markets and must be resilient during times of market stress.

Notes:

  • Past performance is no guarantee of future results. All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss.
  • Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.
  • Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.