The Bank of England’s new bond-buying programme ran into trouble on its second day of operations on Tuesday, as pension funds and insurance companies struggling with a deepening funding crisis refused to sell gilts to the central bank.
It started off well enough.
On the first day of the Bank of England’s resumption of Gilt QE after the central bank had put its monetization of bonds on hiatus in 2012, bondholders were perfectly happy to offload to Mark Carney bonds that matured in 3 to 7 years. In fact, in the first “POMO” in four years, there were 3.63 offers for every bid of the £1.17 billion in bonds the BOE wanted to buy.
However, earlier today, when the BOE tried to purchase another £1.17 billion in bonds, this time with a maturity monger than 15 years, something stunning happened: it suffered an unexpected failure which has rarely if ever happened in central bank history:only £1.118 billion worth of sellers showed up, meaning that the BOE’s second open market operation was uncovered by a ratio of 0.96. Simply stated, the Bank of England encountered an offerless market.
This year’s dramatic fall in yields on bonds issued by investment grade sovereigns has again raised the risk that a sudden interest rate rise could impose large market losses on fixed-income investors around the world, Fitch Ratings says. A hypothetical rapid reversion of rates to 2011 levels for $37.7 trillion worth of investment-grade sovereign bonds could drive market losses of as much as $3.8 trillion, according to our analysis.
Unconventional monetary policies in Japan, Europe and the US, together with a surge in investor demand for safe assets, pushed sovereign yields to new lows in 2016, with $11.5 trillion in sovereign securities trading at a negative yield as of July 15. This figure fell slightly from the June 27 total of $11.7 trillion as a result of changes in dollar-yen exchange rates and a slight uptick in yields for long-term Japanese government securities.
Global bond investors have seen significant gains this year, particularly on longer-term fixed-rate securities where prices are most sensitive to changes in interest rates.
As rates hit record lows, investors face growing interest rate risk. A hypothetical rapid rate rise scenario sheds light on the potential market risk faced by investors with high-quality sovereign bonds in their portfolios.
Global composite yield curves, derived by Fitch from median yields of the 34 IG-rated countries (with at least $50 billion of outstanding debt) in July 2016 and July 2011, fell across all maturities over the past five years. Median yields on 10-year securities are 270 basis points lower than they were in July 2011. At the shorter end of the curve, median yields on 1-year securities have fallen by 176 bps.
There are four events this week that will command the attention of global investors.
1. The Reserve of Bank of Australia is first. It is a close call, though the median in the Bloomberg survey favors a cut, including most of the banks in Australia that participate in the poll.
The case for it is that price pressures are weakening, and credit growth is slowing. The currency has begun appreciating again, and the Federal Reserve cannot be counted on to lift US rates until the end of the year, at the earliest.
The argument against the RBA moving is that there is no urgency to exit the “watch and wait” mode. A rate cut would not necessarily weaken the currency as Australia would still offer highest policy rate (after New Zealand) among the high income countries. It is also not clear that the record low interest rates are a constraint on credit growth. Better keep the powder dry and see how events evolve, though it can be fairly confident that New Zealand will cut interest rates later in August.
2, Investors are more confident of the outcome of the Bank of England’s meeting than the RBA meeting. After the recent dismal survey readings, indicative prices suggest that a 25 bp rate cut is fully discounted. A newswire survey found 95% of the sample anticipated a rate cut, and of those, 95% expect a 25 bp cut in the base rate.
There are two other measures that the BOE is expected to consider. A little more than 80% of those who expect the BOE to do more than cut rates expect the funding for lending scheme to be extended. Participants are nearly evenly split on the prospects for a new round of asset purchases. About half of those that expect a new round of QE expected it to be between GBP25 and GBP50 bln. Outside of that ranges the response were heavily in favor of a larger than a smaller Gilt buying program.
Sterling eased to the lower end of a $1.30-$1.35 trading range as the market priced in the easing of monetary policy. It may firm back toward the upper of the range as the soft US dollar environment we anticipate, coupled with “sell rumor, buy fact” type of activity. In the futures market, speculators have a near record short gross sterling position and have a record net short position.
Even though the country reached 43 per cent of its fiscal deficit target in the first two months of 2016-17 itself, Singaporean brokerage DBS on July 29 said it does not see a slippage for the full year.
“For this year, we don’t see a fiscal slippage, even as quality of adjustment is questionable,” it said in a note released after official data said that fiscal deficit reached 43 per cent of the yearly target in May.
In the past, there have been voices, including from the central bank, which have suggested looking at the “quality” of the deficit, or whether the borrowings are used for more productive purposes.
Conceding that the 43 per cent number looks “precarious”, the brokerage said the start of a new fiscal year experiences slower revenue collections on the direct taxation front but there is front-loading of expenditure.
It said over the course of the year, revenues will get a leg up through the expected higher indirect tax collections, but underlined that non-tax receipts targets through spectrum sales and divestment at 1 per cent of GDP are “ambitious”.
The Bank of Japan’s small expansion of monetary easing Friday could be the warmup for a bold offensive next time around in concert with fiscal policy moves.
The central bank’s statement on the “enhancement of monetary easing” drew attention not so much for its immediate impact, as for the pledge to “conduct a comprehensive assessment” of economic and price developments when the policy board next meets. This is aimed at hitting the target of 2% price growth “at the earliest possible time” — phrasing that inevitably calls to mind the possibility of further easing. BOJ Gov. Haruhiko Kuroda, for his part, did not rule out that interpretation when speaking to media after the meeting.
The governor emphasized the importance of a healthy mix of fiscal and monetary measures. Most likely, any expanded easing will complement whatever large-scale stimulus the government has in store.
On its own, bold fiscal spending funded by Japanese government bonds would put upward pressure on long-term interest rates by sucking up capital from the private sector. Adding stronger monetary easing to the mix combats that pressure, maximizing the impact of stimulus. Such a combination also would likely be easier for the BOJ to swallow than bolstering the economy with monetary policy alone.
The central bank’s policy board will next meet for two days starting Sept. 20 — good timing in relation to fiscal policy mileposts. Prime Minister Shinzo Abe’s government will unveil its stimulus package Tuesday. By the end of August, government ministries and agencies will have put in funding requests for the fiscal 2017 budget. Another supplementary budget for this fiscal year will be brought before the Diet when an extraordinary session convenes in September.
The Australian dollar has slid and shares have pared gains after Standard & Poor’s downgraded its outlook on Australia’s AAA credit rating to “negative”.
Australia’s sovereign debt still holds the top rating from all three major ratings agencies, but S&P now warns the country needs to take drastic action to remedy its budget, lest it potentially suffer a ratings downgrade
The negative outlook on Australia reflects our view that without the implementation of more forceful fiscal policy decisions, material government budget deficits may persist for several years with little improvement. Ongoing budget deficits may become incompatible with Australia’s high level of external indebtedness and therefore inconsistent with a ‘AAA’ rating.
Owing to the deadlocked outcome of the July 2 general election that has yet to hand either of the major parties an outright majority in either the upper or lower houses of parliament, the agency said it believes “fiscal consolidation may be further postponed.”
Here’s a quick round-up of the new record lows set on Wednesday:
US 10-year: 1.3180%
US 30-year: 2.0984%
UK 10-year: 0.729%
German 10-year: -0.205%
Japan 10-year: -0.282%
Switzerland 10-year: -0.629
France 10-year: 0.1005%
Sweden 10-year: 0.0745%
Denmark 10-year: -0.0059%
What do investors want? Top tier government bonds!
When do they want it? Now!
Risk aversion is dictating the mood in the market for a third straight day on Wednesday, with equity markets coming under pressure and demand for haven assets pushing yields on US government bonds to fresh record lows.
The yield on the benchmark 10-year Treasury note fell by nearly another six basis points to 1.3180 per cent during early morning trading in the US, breaking the previous intraday low of 1.3549 per cent set just yesterday.
It was a similar story for the 30-year Treasury note, with yield hitting a new low of 2.0984 per cent in early trading, easily beating the record intraday low of 2.1294 per cent set just a day earlier.
As the government bond rally soars to new heights, yields on a further $1.2tn worth of debt have turned negative since the UK’s referendum on EU membership, according to Citi. True to form, UK government bonds have also hit new highs today.
Citi says 10 countries are now seeing more than half of their government bonds trading with negative yields, and puts the total negative yielding universe at $7.5tn,
A large chunk of debt is on the verge of entering negative yield territory, with the 10-year yields of Denmark and the Netherlands just a few basis points above zero.
Since the December 2015 Report, global financial markets have experienced significant volatility. Equity indices have fallen substantially in some markets. Sterling and euro-denominated investment-grade corporate bond spreads have risen, and ten-year government bond yields have fallen by between 50 and 90 basis points. A substantial element of these moves occurred after the referendum, indicating that the United Kingdom’s decision to leave the European Union was seen as affecting the outlook for the global economy, particularly in the euro area.
The Brexit-charged race to the bottom for government bond yields is posing a new headache for the European Central Bank.
Nearly €1 trillion of eurozone government debt has now fallen below the eligibility criteria for the ECB’s quantitative easing scheme, accelerating by €253bn in the last two weeks of June
That means nearly 18 per cent of the entire €5.8tn market for outstanding eurozone government debt is yielding under the minus 0.4 per cent limit imposed by the ECB – underscoring the supply constraints facing eurozone policymakers in their bid to stimulate growth and inflation through mass bond-buying.
In total, ineligible debt amounts to €984bn of government paper with maturities between two and 30 years, according to data compiled by Tradeweb.
Meanwhile, more than half of the entire universe of euro-denominated sovereign debt (55 per cent) has also fallen into sub zero territory, amounting to €3.14tn.
Considered a haven assets in times of financial stress, government bonds have been on a turbo-charged rally in June, and have been given an additional fillip by the UK’s momentous decision to quit the EU. This has raised even more concerns about the state of insipid global growth, raising expectations for yet more central bank stimulus.