The Wall Street Journal - 16.03.2020

B10| Monday, March 16, 2020 THE WALL STREET JOURNAL.

Spreadbetweenone-yearTreasuryyieldsandmarketexpectations

ofinterestrates*

Source: Refinitiv

*Measured by one-year overnight index swaps

0.4

–0.6

–0.4

–0.2

0

0.2

pct. point

2007 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20

HEARD

ON

THE

STREET

FINANCIAL ANALYSIS & COMMENTARY

China’sannualtrade

valuebycountry

Source: Wind

$700

200

300

400

500

600

billion

2010 ’12 ’14 ’16 ’18

EuropeanUnion

U.S.

Japan

The last week’s rout provided an uncomfortable echo of 2008.

LUCAS JACKSON/REUTERS

dicting where asset values

wind up, she said.

Meanwhile, concerns grew

about exchange-traded prod-

ucts that use leverage to am-

plify returns. Two Wis-

domTree Investments Inc.

instruments were forced to

shut down last week following

the biggest drop in oil prices

since the first Gulf War.

The instruments, traded on

European exchanges, and with

a combined $10 million in as-

sets used derivatives in a bid

to multiply by three times

gains on oil futures. It also am-

plified losses. Monday’s energy

rout caused one instrument to

lose more than 90% in value;

the other fell by nearly 85%.

WisdomTree has been

working to return money to in-

vestors, a spokesman said.

ETF managers and traders

said such issues were rare in-

stances of instability in lever-

aged kinds of exchange-traded

products, and the functioning

of the most of ETFs showed

the machine works as de-

signed.

“Volatile times are a test for

ETFs,” said Jim Ross, the out-

going chairman of State Street

Global Advisors’ ETF business.

“ETFs are passing the test with

flying colors.”

State Street’s SPDR S&P

500 ETF Trust powered more

than $110 billion in its trading

world-wide on Feb. 28, an all-

time high for one of the

world’s first ETFs. Known by

the ticker SPY and consis-

tently one of the world’s most-

traded securities, it drove over

$50 billion in trading for 14

consecutive days as of Thurs-

day, a record.

NetflowsintoU.S

exchange-tradedfunds*

Sources: Morningstar (flows); Cboe Global Markets (share of equities trading)

*Flow figures are weekly estimates.

$20

–15

–10

–5

0

5

10

15

billion

Jan. Feb. March

Exchange-tradedproducts’

shareofequitiestradingon

U.S.exchanges

40

20

25

30

35

%

Jan. Feb. March

to their factories, but they also

need consumers and companies to

buy the goods they make. Unlike

during the trade war, when China

was mainly dealing with disrup-

tions to business with the U.S.,

there seems likely to be a simulta-

neous plunge in demand from all of

the country’s major trading part-

ners.

Easier monetary policy is likely

coming, especially since lower

rates globally mean Chinese au-

thorities needn’t worry so much

about capital outflows and yuan

weakness.

But the stimulus may not be

enough to offset the external

shocks as the government is wor-

ried about further fueling what al-

ready looks to be a property bub-

ble. Chinese banks also prefer to

make safe loans to large, state-

owned companies instead of help-

ing the kind of small, private com-

panies that are truly in need. That

suggests Chinese government

bonds may be better bets than

stocks as growth slows.

China may have contained the

epidemic within its borders, but the

economic consequences will likely

continue to widen.

—Jacky Wong

repeatedly warned about new reg-

ulations clogging the arteries of

the financial system. Banks are

safer, but face higher costs for ex-

panding their balance sheets and

must hold more liquid assets. This

is supposed to prevent a scenario

like the fall of 2008, when they

had to sell in a panic and drove

markets into a collapse.

The flip side is banks can no lon-

ger handle all the securities that

fund managers are eager to trade—a

problem that may have extended to

Treasurys. Nor can they extend

short-term loans as freely, constrain-

ing the supply of dollars.

The Fed is mulling an easing of

bank liquidity rules and its actions

over recent days could help ease the

problem of dollar scarcity if U.S.

banks lend it abroad. If not, the Fed

now has “swap lines” with its estab-

lished peers abroad. This system, es-

tablished after the last crisis, means

the U.S. can easily provide dollars to

Western countries that need them.

Over the past few years, central

banks bought a lot of corporate

paper through quantitative-easing

programs. This has had little effect

on the economy, but is a key tool

to ensure market liquidity that the

Fed could deploy. Emergency facil-

ities tested out in 2008 could also

make a comeback.

This doesn’t mean that all market

distortions can be fixed. For one, the

brutality of the recent rout was

likely exacerbated by the large num-

ber of traders betting against volatil-

ity in the preceding months. And

when it comes to the economic im-

pact of Covid-19, monetary policy

can do very little.

But investors should take solace

from these early signs that—perhaps

unlike the European Central Bank—

the Fed seems committed to ensur-

ing the smooth functioning of mar-

kets. When it comes to market

liquidity, a virus cannot win a fight

with the U.S. central bank.

—Jon Sindreu

The coronavirus is putting the fi-
nancial system that emerged from
last decade’s banking crisis to the
test. Initially, markets appeared to
pass. Over the past few days, they
have started to buckle.
The good news is that the Federal
Reserve learned a lot during the
2008 crisis. If it doesn’t renege on
its unofficial role as the world’s mar-
ket maker, it should be in a position
to fix most problems.
On Sunday, the Fed surprised the
market by slashing rates to zero and
agreeing to buy $700 billion in Trea-
surys and mortgage-backed securi-
ties. This follows Friday’s smaller
commitment and a $1.5 trillion li-
quidity injection unveiled Thursday.
These are necessary steps after
a turbulent week in which fund
values have shown signs of dislo-
cating from the value of the assets
they own, an uncomfortable echo
of 2008. Even the market for U.S.
government bonds, the safest and
most liquid in the world, is under
pressure. Over recent trading ses-
sions, Treasury yields have
bounced back—an oddity in times
of panic. Relative to derivatives
markets in which investors bet on
future interest rates, Treasurys are
trading at their steepest discount
since the global financial crisis.
Before panicking, though, inves-
tors should recall that the Fed has
what it takes to mend the market
plumbing. Its latest actions should at
least ease any potential concern
about Treasurys—an essential haven
asset for the entire world—being
safe. It confirms that, ultimately,
sovereign debt is always backed by
the central bank.
Another concern last week, par-
ticularly in global markets, was dol-
lar scarcity. On Thursday, spreads on
euro and yen cross-currency basis
swaps—an instrument often used by
companies outside the U.S. to bor-
row greenbacks in exchange for their
own currencies—jumped to levels
reminiscent of the 2011 euro crisis,
during which international lenders
scrambled to source dollars.
Over the past decade, investors

Fe d C a n

Probably

Handle Hit

To M a r k e t s

It seems willing to do

what is necessary

U.S. investors largely ignored

the spread of the new coronavirus

in China. Chinese investors

shouldn’t make the same mistake

as it spreads in the U.S.

Covid-19—the disease caused by

the new virus—has gone global.

There are now more new cases out-

side of mainland China, where the

outbreak is believed to have begun,

than inside it.

While Italy has locked down its

country and sports events in the

U.S. are being canceled, business in

China is slowly getting back to nor-

mal.

This may be one reason why Chi-

nese markets have been resilient

even as U.S. stocks have tumbled

into bear-market territory.

The CSI 300 Index, a gauge of

the largest stocks in Shanghai and

Shenzhen, fell 1.6% in the past

month, versus a 26% decline in the

S&P 500.

Another reason is likely the rel-

ative isolation of China’s financial

system, which insulates it from

global trends. Foreign investors

still only own around $200 billion

of mainland Chinese stocks, or

2.1% of their total value, according

to Wind. That makes the net $7.7

billion they have sold in the past

month relatively inconsequential.

Even in Hong Kong, which is

closely tied into the global finan-

cial system, Chinese stocks have

only dropped 11% in the past

month. Investors seem to be bet-

ting that the crisis in China is

mostly over.

That seems premature, given

the continuing uncertainties. The

disease may flare up again when

more people get back to work.

New cases could be imported from

outside China. Small businesses

and workers who have been hit

hard by the disruptions may take a

long time to regain their footing.

Even more important, as the

world’s largest exporter, China isn’t

immune from economic shocks in

other major economies.

There could be supply-chain dis-

ruptions, especially for such items

as cars and electronics, if factories

in Europe and the U.S. are shut

down—just as when large parts of

the Chinese economy were shut

down.

And with many major economies

now flirting with recession, global

demand is set to take a hit. Chi-

nese workers may be able to return

China Isn’t Immune

To Stock Turmoil

MARKETS

Morningstar data on U.S. funds

through March 6. Bond ETFs

took in $7 billion in net flows

as some turned to their per-

ceived safety or looked to bet

on changing interest rates.

Yet highly volatile markets

are testing the stability of

ETFs and their trading ecosys-

tems. And money going into

bond ETFs has reignited fears

around whether they will be

able to withstand a flood of

sell orders if market stress

deepens since their underlying

securities often aren’t as liq-

uid, say, as stocks.

The concern grew after

some bond ETFs, closed at

wider discounts to net asset

value than normal in the past

week. At the same time, fears

have grown over whether

highly leveraged companies

can pay back their debt with

the disruptions caused by the

coronavirus.

The iShares iBoxx USD In-

vestment Grade Corporate

Bond ETF closed at a roughly

5% discount to net asset value

on March 12, according to

FactSet. The fund’s trading

prices have typically tracked

the value of its underlying as-

sets much more closely.

BlackRock in its latest

statement on ETFs said “un-

precedented deterioration of

market quality in bond trading

around the globe” led to price

differences between fixed in-

come ETFs and underlying

bonds on Thursday.

Such disparities are often a

reflection of a lag in data, said

Elisabeth Kashner, director of

ETF research at FactSet. Bond

pricing services that feed into

benchmarks and asset values

typically are slow to update

prices during market up-

heaval, and ETFs end up pre-

During periods of intense

market volatility, some inves-

tors used ETFs as substitutes

for futures when liquidity

shrank in those instruments.

Not all ETF trading involves

trades of their underlying

stocks or bonds and can occur

when investors exchange exist-

ing ETF shares.

“In recent weeks the liquid-

ity in the marketplace and par-

ticularly futures were thin,”

said Reginald Browne, a prin-

cipal at ETF market maker

GTS. “So all of a sudden ETFs

became the choice vehicle for

hedging and to take directional

bets.”

Liquidity has a price. Some

investors faced new costs as

bid-ask spreads on some ETFs

widened. That is the difference

between the highest price an

ETF investor will pay and the

lowest price a seller will ac-

cept. These typically amount

to at most pennies per share,

but add up with heavy trading.

The spreads go to what banks

and middlemen earn for the

risks of handling trades.

Average bid-ask spreads on

exchange-traded products rose

to 0.38% for the week of March

1 and 0.32% in the week of Feb.

23, from 0.22% to 0.26% in

prior weeks of this year, Cboe

data show. Wider spreads re-

flect more uncertainty around

pricing of ETFs and their un-

derlying securities.

“Spreads are the expression

of the balance between fear

and greed,” said FactSet’s Ms.

Kashner. For market makers,

“fear will push you to widen it

because you’re less certain

about the profitability of the

trade so you’re going to push

it.”

—Joe Wallace

contributed to this article.

Exchange-traded funds have
become the tool of choice for
many investors grappling with
the market tumult sparked by
the spread of the coronavirus.
In the first week of March,
exchange-traded products
powered more than a third of
equities trading on U.S. ex-
changes, up from 24% in the
month-prior period, according
to Cboe Global Markets.
Last Monday, exchange-
traded products made up
nearly 40% of trading. That
amounts to investors trading
roughly $300 billion in ex-
change-traded products—mul-
tiple times what they traded
on average each day in the
first few weeks of the year, ac-
cording to a Wall Street Jour-
nal analysis of data from Cboe
and the Tabb Group.
The surge is the latest sign
of ETFs’ importance to traders
when news moves faster than
trading in individual instru-
ments such as stocks and
bonds. ETFs are collections of
securities and trade like stocks
on exchanges.
These funds have let every-
one from individual investors
to big pension funds trade en-
tire markets or sectors at
rapid speed. Their invention
and ensuing popularity turned
BlackRock Inc., Vanguard
Group and State Street Corp.
into asset-management behe-
moths, and created a $6 tril-
lion industry.
Movements among different
types of ETFs highlighted
wider shifts in financial mar-
kets. Investors, for instance,
pulled more than net $15 bil-
lion from equity ETFs in the
past two weeks, according to

BYDAWNLIM
ANDMISCHAFRANKL-DUVAL

ETFs Were Where the Action Was During Rout

Foreigners own around

$200 billion of mainland

Chinese stocks, or 2.1%

of their total value.

The funds’ popularity turned firms such as Vanguard Group into asset-management behemoths.

RYAN COLLERD FOR THE WALL STREET JOURNAL