After being surprised by the lack of an interest rate cut in the U.K. this month, investors shouldn't be so sure they know what Mark Carney's next move will be.
The Bank of England Governor will likely spurn the latest fashion among central bankers — buying corporate bonds — according to Citigroup Inc. analysts led by Hans Lorenzen, who said their call jars with market expectations. As they wrote:
“Trendsetter” might not be the first word that comes to mind when you think of your archetypal central banker, but monetary policy is in many ways as susceptible to what’s à la mode as any fashionista. Be it inflation targeting, liquidity backstops, quantitative easing or negative rates, where one central bank has gone typically others have followed. Is corporate bond buying the next fad?
Carney and his colleagues have signaled they expect monetary policy to be loosened next month, causing speculation of rate cuts as well as a potential expansion of the BOE's asset purchase facility. And while it is possible the central bank could buy company debt — it previously had a program for acquiring the bonds in 2009 — it would likely only do so after a greater deterioration in financial markets and greater strains in the corporate sector, said the Citigroup analysts.
Other reasons why the analysts suggest the probability of corporate bond purchases is low, are that the BOE might want to keep some options on the table if it needs to take further action to shore up markets in the future, and it could instead buy mortgage-backed bonds or revive its Funding for Lending scheme.
Still, the markets have their own take. The yield premium, or spread, over benchmark interest rates investors demand to hold sterling-denominated company bonds is now less than it was before Britain voted to leave the European Union. And that's because investors are "putting a relatively high probability" of the BOE buying the debt, according to Citigroup.
Credit spreads for investment grade-rated pound bonds are 14 basis points tighter than they were on June 22, the day before the U.K.'s referendum, while spreads on similarly rated dollar bonds are only 8 basis points tighter, according to Citigroup. Spreads on riskier junk bonds and mortgage-backed securities have not tightened as much. (The European Central Bank, which is currently buying corporate debt as part of its asset purchase program, is only acquiring high-grade bonds so that is the part of the sterling market investors are focused on.)
In many cases, investors got the outcome of the Brexit referendum wrong, whether they get the BOE's response right awaits to be seen.