After inflation, a possible bond supply shock to the market

FILE PHOTO: People are seen on Wall St. outside the NYSE in New York
FILE PHOTO: People are seen on Wall St. outside the New York Stock Exchange (NYSE) in New York City, U.S., March 19, 2021. REUTERS / Brendan McDermid / File Photo

December 20, 2021

By Dhara Ranasinghe

LONDON (Reuters) – Central banks, the developed world’s most trusted group of bond buyers, could cut debt purchases by up to $2 trillion next year in the four major advanced economies. , which means that borrowing costs for many governments are likely to rise.

For many years, but especially since the COVID-19 pandemic broke out in March 2020, central banks have effectively supported government spending, cutting a significant proportion of debt outflows. market and prevent yields from rising too high.

But if central banks set a timetable for pandemic-era stimulus, the scarcity of highly-rated bonds, especially in Europe, could turn into a glut.

JPMorgan estimates demand for central bank bonds across the US, UK, Japan and the eurozone will fall by $2 trillion in 2022 after falling $1.7 trillion this year.

It expects 10-year US, German and UK yields to increase by 75, 45 and 55 basis points, respectively, by the end of 2022, though it did not specify the impact of supply on bonds.

Globally, JPMorgan predicts central banks will lead to a drop in bond purchases of about $3 trillion, resulting in an average yield increase of 20-25 basis points.

“I’m not suggesting next year will be Armageddon – but you’ve got a period where inflation is still high, central banks are behind the curve in terms of rate hikes, and at the same time you’ve Craig. Inches, head of currency and cash at Royal London Asset Management, said.

“It’s a pretty complicated mix for the bond market.”

The US Federal Reserve will end its $120 billion monthly buying period in March. The Bank of England’s 895 billion pound ($1.18 trillion) bond-buying scheme ends this month, while the 1.85 trillion euro ($2.09 billion) Emergency Purchase Program ends this month. billion USD) of the European Central Bank will expire in March.

Central banks are not going to disappear from the market. To offset the PEPP drawdown, the ECB will temporarily double its existing monthly stimulus to €40 billion, while the Fed and BoE will continue to pull money from maturing bonds back into the market.

Overall, the impact is negative.

The UK may be the most affected market. ING estimates that private investors will have to absorb a net £110bn of gilts in 2022 compared with £14bn this year, as BoE bond purchases in 2021 are close to £170bn.

Furthermore, the BoE plans to stop reinvesting proceeds from maturing debt when interest rates hit 0.5%, which could happen in mid-2022. When interest rates hit 1%, it could watch consider selling off the bonds they own.

According to RLAM’s Inches, the UK government’s total borrowing scheme means an average of £120 billion in annual net issuance over the next four years, levels not seen since 2011, RLAM’s Inches said. . He expects 10-year yields to double by the end of 2022 from around 0.75% today. (Illustration: UK Gold Plated Production over a two-year period,


It is in stark contrast to a year ago when central banks started to increase printing.

In the euro area, the yield premium could rise by 20-30 bps, according to Ralf Preusser, head of global exchange rate research at BofA.

If markets are pricing right at the end of all asset purchases next year, “the interest rate shock is even larger and risks becoming a very significant part of the positive net issuance that we need to absorb for the first time since the European sovereign (debt) crisis,” said Preusser.

“European arbitrage is not priced in for that,” he added. (Graphic: Supply Outlook from BofA,

France looks particularly vulnerable; it pays a meager 35 bps yield premium compared to Germany, less than a quarter of Italy’s, but according to Unicredit it will have the largest amount of debt excluding ECB purchases. It estimates net issuance of around 120 billion euros by 2022.

Total euro supply, including European Union bonds, will be the highest since 2015 at 157 billion euros, said BNP Paribas head of strategy for G10, Europe interest rates, Camille de Courcel.

“The net supply picture will change dramatically next year amid a sharp drop in (central bank) buying, and due to the fact that aggregate supply will remain relatively high,” she said. (Figure: Estimated ECB purchases vs net market issuance,

US supply may be lighter.

ING analysts say the annual decline in Fed purchases of up to $1 trillion will be offset by a $1.5 trillion decline in Treasury net issuance. That means “overall net supply pressure will be reduced by about $0.5 trillion,” they told clients.

Given perennial overseas demand for Treasuries, that should cap 10-year yields – a Reuters poll found a late 2022 level at 2.08% while most banks expect a about 2.25%. This is about 85 bps higher than it is now, despite a slight Fed cut and three likely rate hikes.

(Reporting by Dhara Ranasinghe; additional reporting by Sujata Rao in London and Stefano Rebaudo in Milan; Editing by Sujata Rao and Catherine Evans) After inflation, a possible bond supply shock to the market

Bobby Allyn

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