There are known knowns...

It was 2002 when General Donald Rumsfeld, in an official news briefing of the DoD amused the press with a nice speech on the vast theme of "lack of evidence".

The conclusion was that "there are also unknown unknowns—the ones we don't know we don't know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones".

In this particular situation, looking at the market, we see a level of volatility pretty similar to 2008. Back then, I was a junior strategist in a fixed income desk, all people were analyzing compulsively the triggers of the crisis but no one could even imagine the actual consequences in the medium term.

Nowadays Equity indexes are rapidly dropping to level seen back then, fixed income investors are starting to liquidate assets. 

Traders of BTP's are seeing rapid increase of spreads (ok, trader's preferred sports in trouble times is to short btps... pretty trivial...), credit spreads are becoming a bitter spot and (I guess but please feel free to add here) liquidity by now will be in pretty horrible conditions. 

Now people are starting to liquidate also more safe assets (long term treasuries ad an example. Another example is gold even if physical supply will be a mess in forthcoming weeks with a pretty strong demand).

Everything is pointing to a "cash is king situation", projecting not only a protracted recession buy (may be) to a more sour situation.

We are now a few steps away from consideration regarding the sustainability in the medium-long term of the rapid increase of fiscal spending of pretty all countries in the world. 

What a mess.

But what are the "unknown unknowns — the ones we don't know we don't know"?

Few guess:

- Timing: viral peak will be in 4/5 weeks from the 100th contagion? will the peak be shortly followed to a back-to-normality in consumption and production?

- Leverage: this has much to do with next bullets. My perception is that globally leverage is back near to 2007 levels. How much, I really don't know. For sure BBB assets are a lot more than a few years ago, and investment in sub IG have flooded the market in past years. This could produce a weave effect in case of liquidation of assets, creating a spiral that will be hardly stop by liquidity injection. Ban of short selling could help but when margins calls....

- Liquidity (market edition): the good news is that when bids will end on the street, price discovery will be harder but will lead to slightly higher prices. In the aftermath of 2008 price dislocation was huge. Will we see more of the same in the next weeks? 

- Liquidity (corporate edition): with the shut down of factories, small business and some service activity in the next (hopefully) weeks corporate will be stranded and more leveraged business will find hard to cope with fixed costs. 

Many analyst have already foretasted a spike in delinquencies that will be mitigated by fiscal spending aimed at supporting consumer and corporates. 

Will fiscal spending be enough to mitigate this? Will be fast enough to compensate the liquidity drain?  

Is current global leverage level (and taxonomy) the "unknown unknowns" that will materialize a fallout effect of corona-virus spread in the medium and long term?

Are the "Circuit-breakers" already in place enough or we need something more down the line?

Michele Romano

Disclaimer:

The view expressed in the article represent the sole author view. It does not representin any way his employer view ad it has not been authorized by the employer itself.