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Bonds to get by without a little help from central banks
PARIS, Jan 21, 2018 (BSS/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.
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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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