Central banks, the developed world’s most reliable group of bond buyers, could slash debt purchases next year by as much as US$2-trillion across the four big advanced economies, implying a potentially hefty rise in many governments’ borrowing costs.
For years, but particularly since the COVID-19 pandemic erupted in March, 2020, central banks have effectively backstopped government spending, mopping up a significant proportion of the debt hitting markets and preventing yields from rising too high.
But if central banks set a schedule for unwinding pandemic-era stimulus, a dearth of highly rated bonds, especially in Europe, may turn into an excess.
JPMorgan Chase & Co. estimates central bank bond demand across the United States, Britain, Japan and the euro zone will drop by US$2-trillion in 2022 after a US$1.7-trillion reduction this year.
It expects U.S., German and British 10-year yields to rise 75, 45 and 55 basis points, respectively, by end-2022, although it did not specify the impact of supply on bonds.
Globally, JPMorgan predicts central banks will lead a roughly US$3-trillion drop in bond buying, translating into an average yield rise of 20 to 25 basis points.
“I am not suggesting next year is going to be bond Armageddon – but you’ve got a period where inflation is still stubbornly high, central banks are behind the curve in terms of raising interest rates, and at the same time you’ve got large net supply,” said Craig Inches, head of rates and cash at Royal London Asset Management.
“That’s quite a heady mix for bond markets.”
The U.S. Federal Reserve will end the phase-out of its US$120-billion monthly purchases in March. The Bank of England’s £895-billion (US$1.18-trillion) bond-buying scheme ends this month, while the European Central Bank’s €1.85-trillion (US$2.09-trillion) Pandemic Emergency Purchase Programme (PEPP) will expire in March.
Central banks won’t vanish from markets. To compensate for withdrawing PEPP, the ECB will temporarily double existing monthly stimulus to €40-billion, while it, the Fed and the BoE will continue plowing proceeds from maturing bonds back into markets.
Over all though, the impact is negative.
Britain could be the market most affected. ING estimates private investors will have to absorb a net £110-billion of gilts in 2022 versus £14-billion this year, given 2021′s BoE bond purchases of almost £170-billion.
What’s more, the BoE plans to stop reinvesting proceeds of maturing debt once interest rates reach 0.5 per cent, a level that’s possible by mid-2022. Once rates hit 1 per cent, it may consider selling off the bonds it owns.
Gross British government borrowing plans imply an average £120-billion in annual net issuance over the next four years, levels not seen since 2011, RLAM’s Mr. Inches says. He expects 10-year yields to double by end-2022 from roughly 0.75 per cent now.
‘NOT PRICED’
It’s a stark contrast with a year ago when central banks were cranking up the printing presses.
In the euro zone, yield premiums may rise 20 to 30 basis points, according to Ralf Preusser, global head of rates research at BofA.
If markets are correct in pricing a complete end to asset purchases next year, “the rate shock becomes even bigger and risks being a very significant chunk of positive net issuance that we would need to absorb for the first time since the European sovereign [debt] crisis,” Mr. Preusser said.
“Spreads in Europe are not priced for that,” he added.
France looks especially vulnerable: It pays a meagre 35 basis points yield premium over Germany, less than a quarter of Italy’s, yet according to Unicredit it will have the largest volume of debt not covered by ECB purchases. It estimates net issuance at around €120-billion in 2022.
Over all euro supply, including European Union bonds, will be the highest since 2015 at €157-billion, BNP Paribas’s head of strategy for G10 rates, Europe, Camille de Courcel said.
“The net supply picture is changing dramatically next year amid a strong deceleration of [central bank] purchases, and in light of the fact that gross supply will still remain relatively elevated,” she said.
U.S. supply may be lighter.
ING analysts say the wind-down of Fed purchases amounting to US$1-trillion annualized will be offset by a US$1.5-trillion drop in Treasury net issuance. That means “overall net supply pressure will shrink by some $0.5 trillion,” they told clients.
With perennial overseas demand for Treasuries, that should cap 10-year yields – a Reuters poll sees end-2022 levels of 2.08 per cent, while most banks expect around 2.25 per cent. That is around 85 basis points higher than now, notwithstanding a Fed taper and three likely rate hikes.
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