Building a Bridge


The US economy has suffered a massive heart attack, and the government, along with the Federal Reserve, have to build a fiscal and monetary policy bridge to help get the patient from here (middle of the heart attack) to there (recovery room). While the typical recession sees a modest contraction in output, this contraction is enormous as many industries have come to a complete standstill.

Given the massive scope of this contraction, the fiscal and monetary authorities have to step in and provide the type of medicines that are sorely needed, namely:

  1. The government is rightly working on a fiscal package to aid the industries and workers most affected. Yes, $2 trillion is a lot, but it aims to plug a similar-sized economic contraction.
  2. The Fed is easing policy and becoming the liquidity provider of last resort by creating an alphabet soup of programs targeting various lending markets.

What does this mean for the markets?

After lots of carnage, we are starting to see some positive developments on the liquidity front thanks to this Fed action. Equity markets cannot sustainably rally if the credit and funding markets are broken. This is why what the Fed is doing is so important. It significantly addressed and brought relative stability back to the Treasury market (off which spread assets are priced) and high-quality fixed income assets like agency mortgage-backed securities (MBS). Then, it went further down the chain to target the front end of the investment grade corporate market—a market which had developed huge dislocations (i.e., massively inverted credit curves) due to liquidity needs. By stabilizing the high quality end of the market (Treasurys and agency MBS) and then providing liquidity at a known price to other parts, the ground is being laid for an eventual market normalization (exhibit 1). Not surprisingly, high yield was not included in any of the Fed's programs. Clearly the Fed does not want to take the material principal risk required to get into the junk bond business and, thus, we think credit defaults in this space are likely to increase.

Exhibit 1: US Bloomberg Barclays Fixed-Rate MBS Spread to Treasurys

Source: Bloomberg Barclays. As of 3/25/2020.

Overall, we believe we are seeing the necessary responses to the crisis from both government and monetary authorities to build the bridge to normalization. While this is helping to restart credit flowing in the system, which supports asset prices, we reiterate our caution on the low quality part of the risk spectrum as we see an increasing probability of a new default cycle coming.


This material is to be used for institutional investors and not for any other purpose. This communication is being provided for informational purposes in connection with the marketing and advertising of products and services. This material contains current opinions of the manager and such opinions are subject to change without notice. Aegon AM US is under no obligation, expressed or implied, to update the material contained herein. This material contains general information only on investment matters; it should not be considered a comprehensive statement on any matter and should not be relied upon as such. If there is any conflict between the enclosed information and Aegon AM US' ADV, the Form ADV controls. The information contained does not take into account any investor's investment objectives, particular needs, or financial situation. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to you. The value of any investment may fluctuate. Investors should consult their investment professional prior to making an investment decision. Aegon AM is not undertaking to provide impartial investment advice or give advice in a fiduciary capacity for purposes of any applicable federal or state law or regulation. By receiving this communication, you agree with the intended purpose described above.

The information presented is for illustrative purposes only.

Aegon AM US may trade for its own proprietary accounts or other client accounts in a manner inconsistent with this report, depending upon the short term trading strategy and/or guidelines for a particular client as well as other variables.

Diversification does not ensure a profit nor guarantee against loss.

This document contains "forward-looking statements" which are based on the firm's beliefs, as well as on a number of assumptions concerning future events based on information currently available. These statements involve certain risks, uncertainties and assumptions which are difficult to predict. Consequently, such statements cannot be guarantees of future performance and actual outcomes and returns may differ materially from statements set forth herein.

Aegon Asset Management US is a US-based SEC registered investment adviser and is also registered as a Commodity Trading Advisor (CTA) with the Commodity Futures Trading Commission (CFTC) and is a member of the National Futures Association (NFA). Aegon Asset Management US is part of Aegon Asset Management, the global investment management brand of the Aegon Group.

Recipient shall not distribute, publish, sell, license or otherwise create derivative works using any of the content of this report without the prior written consent of Aegon Asset Management US, 6300 C Street SW, Cedar Rapids, IA 52499. ©2020 Aegon Asset Management US Adtrax Code: 3013111.1. Exp Date: 3/1/2021.

Frank Rybinski

About Frank Rybinski

Frank Rybinski, CFA, Chief Macro Strategist, Aegon Asset Management