Bonds to get by without a little help from central banks

Masters of the markets no more? The end of easy money policies from US Federal Reserve chief Janet Yellen, the President of the European Central Bank (ECB) Mario Draghi, Canadian Mark Carney, the governor of the Bank of England, and the governor of the Bank of Japan Haruhiko Kuroda means …
AFP

Paris (AFP) – The rebound of global growth is sounding the death knell for easy money, so debt markets should see the backs of central banks in 2018, although a gradual withdrawal should help avoid a new tantrum sending interest rates spiking.

The colossal sums that central banks injected into the financial systems to ward off economic cataclysm went primarily into the debt markets, which will have the biggest adjustment to make as part of the so-called normalisation of monetary policy by central banks.

As central banks slow down their purchases of debt and then reduce their holdings the interest rates that governments and companies pay to borrow money are expected to climb higher.

While everyone expects borrowing costs to rise in 2018, the key question is whether it will happen smoothly or not. Any disruptions in the credit markets can have a severe impact on the overall economy.

In Europe, where the European Central Bank (ECB) is set to continue buying 30 billion euros of assets each month until September, ultra low or even negative on certain maturities, there is a not of optimism in the air.

“We don’t see a strong break with 2017” said Felix Orsini, who handles government debt issues for Societe Generale’s commercial and investment bank.

“There is a deep resilience of the market, and there is still plenty of appetite for risk and there is a large margin for manoeuvre before the level of dissuasive rates,” he told AFP.

HSBC’s Frederic Gabizon shares that view. He foresees “a moderate increase in rates paid by companies and European states in 2018”.

– US rates in spotlight –

Most bond market experts see the greatest risk as sharp readjustment of the market where interest rates spike higher, as happened in the 2013 “taper tantrum” when investors panicked in reaction to news that the US Federal Reserve would reduce, or taper, its purchase of bonds, thus sending rates of return surging higher.

With the US Fed taking the lead in the normalisation, cutting its holdings of bonds along with raising interest rates, investors and experts are looking at how borrowing costs evolve there.

There have been a few voices of caution, such as S&P Global Ratings and the International Monetary Fund’s chief economist, Maurice Obstfeld.

“If you look around the world, there is a lot debt,” Obstfeld said recently. “If there were a sudden rise in US interest rates, that could put a lot of debtors under stress.”

But Rene Defossez, a London-based debt analyst at French investment bank Natixis, said “central banks aren’t taking any risks, they are normalising their policies on tiptoes and with inflation still extremely weak they don’t have any reason to rush.”  

Eric Vanraes, head of fixed income investments at the Swiss-based Sturdza Banking Group said “it is difficult to imagine the Fed losing its bearings and making too quick an exit. It has learned its lesson.”

– Lessons learned –

In the United States, the Fed did not include corporate bonds in its buying programme, whereas the ECB did. 

But even if European firms will have “live with this exit, without the ECB, the balance between supply and demand is in their favour,” said Orsini at Societe Generale.

Moreover, “since 2008, and that is one of the big lessons of the crisis, companies are preparing for periods” when debt markets are unaccessible and are managing their liquidity prudently, he said.

On the political level, the situation appears to be calmer in 2018 as only Italy has elections, whereas the previous two years had a heavy electoral calendar. 

For debt market analysts, there is a good chance that 2018 will turn out to be a good year, much as 2017 was.

“The ultra low interest rate environment allowed big groups to at once reinforce their financial structures in favourable conditions, but also finance very important” mergers and acquisitions in 2017, said Gabizon at HSBC. 

For Sturdza’s Vanraes, what is most likely to change in 2018 is volatility. 

“After years where the monetary programmes drowned out volatility on all the markets, investors will have to get used again to erratic movements” both in amplitude and duration.  

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