Negative Yields No Bar to Best Bond Market Conditions Since 2009

  • Excess supply to shrink most since recession, JPMorgan says
  • Record low yields ahead as issuance falls, bank predicts

In a world awash with debt, it’s hard to imagine that there may not be enough to go around.

Yet that’s exactly what JPMorgan Chase & Co. says is happening. The world’s biggest bond underwriter predicts record-low global yields ahead, based on forecasts of $1.86 trillion of net worldwide issuance this year versus $1.74 trillion of estimated net purchases. While those figures signal that supply will outstrip demand for the fifth straight year, the key for the bank is that the gap -- the amount of excess issuance -- is set to shrink the most since 2009.

The favorable backdrop is a result of falling government borrowing brought on by austerity measures and increased bond buying by central banks, which have gobbled up more than $12 trillion of assets since the financial crisis to support economic growth and ward off deflation. The outcome would ease concern that the Federal Reserve’s push to raise interest rates will drive up yields and choke off economic growth.

The performance of fixed-income assets worldwide in 2016 backs up JPMorgan’s view. With investors seeking a haven from volatility in stocks, commodities and China, they’ve had little trouble soaking up all the extra debt: Bonds globally have returned about 3.3 percent in 2016, the strongest annual start in Bank of America Merrill Lynch data going back to 1997.

‘Keep Buying’

"Investors are going to keep buying,” said Nikolaos Panigirtzoglou, a market strategist at JPMorgan in London and a former financial economist at the Bank of England. “The economic environment is characterized by high uncertainty and low growth. With yields falling, bond investors will make good money from capital gains."

The resilience of demand is vital because the global debt market’s explosive growth -- to about $100 trillion from $70 trillion in 2007 -- is spurring concern that it may be a bubble ready to burst. Money managers worried about the economic outlook and seeking any incremental return they can get are paying little heed to the naysayers, pouring money into longer, riskier maturities and driving yields to less than half their levels from a decade ago. About $8 trillion of debt worldwide carries negative yields, meaning investors who buy the securities today and hold them to maturity stand to lose money.

“The supply-demand dynamic makes for a challenging environment for interest rates to move up significantly in U.S. Treasuries and Europe sovereign debt," said Barry HoAire, co-head of fixed income in Los Angeles at Bel Air Investment Advisors, which oversees $7 billion.

Big Swing

In its analysis, JPMorgan estimates global borrowing from companies and developed-market governments. It stacks that up against forecasts of potential purchases -- and sales -- from sources such as Group of Four central banks and commercial banks, reserve managers, sovereign wealth funds, pensions and insurers. Market prices adjust to any imbalance between supply and demand.

This year, supply may exceed estimated purchases by $119 billion on a net basis, down from $566 billion last year, JPMorgan calculates. That would be the biggest swing in favor of demand since 2009, amid the worst financial crisis since the Great Depression.

For JPMorgan, the supply-demand backdrop means even lower yields as investors bid up prices on a shrinking pool of available securities. Average yields on the Barclays Global-Aggregate Index will drop as much as 0.5 percentage point this year, the bank predicts. The index yield has already dropped to 1.38 percent from 1.77 percent at the end of last year.

Consensus Defied

The decline runs counter to the consensus, which is for yields to rise across Group-of-Seven nations by year-end, according to the median forecast in Bloomberg surveys. Benchmark 10-year Treasury yields will probably climb to 2.25 percent by year-end, from 1.84 percent as of about 9:30 a.m. in New York Monday. Analysts have ratcheted that forecast lower since the start of January, when the median prediction for the end of 2016 was about 2.8 percent.

Lower yields have been the trend globally. They’ve tumbled this year in 20 developed nations tracked by Bloomberg.

Supply Calculus

On the supply side, government bond sales are dwindling, as seen in the world’s biggest bond market. With the U.S. economy rebounding and the federal deficit contracting the last four fiscal years, the Treasury Department’s net debt offerings are shrinking.

Coming into 2016, primary dealers surveyed by Bloomberg estimated that net sales of Treasury notes and bonds would tumble 27 percent from last year. The decline may be even steeper as tax revenue has eclipsed some forecasts. UBS Securities LLC and RBC Capital Markets LLC are among primary dealers predicting that the Treasury on May 4 will announce further reductions in the size of some note sales.

“Issuance, particularly in the U.S., is going to be less than it has been,” said Christopher Sullivan, who oversees $2.3 billion as chief investment officer at United Nations Federal Credit Union in New York. “You have economic factors and the supply-demand picture running together kind of depressing yields globally.”

European Appetite

On the demand side, the ECB’s stepped-up stimulus efforts are contributing to the purchasing that’s pushing yields lower.

The central bank said in March that it would expand its monthly bond buying to 80 billion euros ($92 billion) from 60 billion, and made corporate debt eligible for the program.

That demand, along with estimated net purchases of about $379 billion from bond funds this year, up from $263 billion in 2015, will help offset selling from other corners, JPMorgan projects. Foreign official selling, including from sovereign wealth funds and reserve managers, will probably tally about $380 billion.

For evidence of how potent investors’ appetite for fixed-income assets has grown, consider the swath of global debt with negative yields as the Bank of Japan and the ECB keep some benchmark rates below zero to buoy growth.

“With the European Central Bank now moving into the corporate space, there’s a new buyer in town,” said Jens Vanbrabant, London-based head of investment-grade bonds at ECM Asset Management, which oversees about $9.5 billion. “A big buyer.”

Following is a table of projected net bond demand in 2015 and 2016, using data compiled by JPMorgan (in billions of dollars):

G-4 Central BanksForeign OfficialG-4 Comm. BanksBond Funds/RetailPension/InsurersTotal ($US)
20151,407-237-3062634991,626
20161,745-380-4603794601,744
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