Bond Speculators Crowded Out in JPMorgan’s Bullish SignalLiz Capo McCormick and Sridhar Natarajan
Major central banks, large commercial lenders and currency reserve managers are poised to boost the share of the bond market they hold next year, helping support fixed-income assets even as the U.S. Federal Reserve pulls back on its stimulus.
That’s the conclusion of JPMorgan Chase & Co., which estimates that the Group of Four central banks, along with the major lenders and reserve managers in their regions, are on pace to own $26 trillion of debt securities worldwide by the end of next year. The holdings would represent 52 percent of the tradeable bond universe, according to JPMorgan.
Non-bank investors worldwide are increasingly being crowded out amid a potential mismatch between bond market supply and demand. Debt made up 31 percent of their total holdings, down from more than 40 percent after the 2008 collapse of Lehman Brothers Holdings Inc., according to JPMorgan.
“The bond overweights that emerged after the Lehman crisis have been eroded,” JPMorgan strategists led by the London-based Nikolaos Panigirtzoglou wrote in a report dated Oct. 3. “This is perhaps one reason that bond markets have held up so well this year despite an overall hawkish Fed.”
JPMorgan is the biggest underwriter of corporate debt worldwide, according to data compiled by Bloomberg, and the top-ranked firm for U.S. fixed-income research by Institutional Investor magazine.
The search for safe assets such as bonds got more acute yesterday after the International Monetary Fund cut its outlook for global growth in 2015 and warned about the risks of rising geopolitical tensions and a financial-market correction as stocks reach “frothy” levels.
The world economy will grow 3.8 percent next year, compared with a July forecast for 4 percent, after a 3.3 percent expansion this year, the Washington-based IMF said. U.S. growth is helping lead a worldwide acceleration that’s slower than the fund previously predicted as the outlooks for the euro area, Brazil, Russia and Japan deteriorate.
The Fed has expanded its balance sheet assets to $4.45 trillion from less than $1 trillion in 2008 in an effort to stimulate growth after the global financial crisis. The Bank of Japan is buying debt and expanding its monetary base by as much as $650 billion a year, and the European Central Bank announced plans to purchase covered bonds and asset-backed securities.
Outside the Fed, a new round of global stimulus is occurring just as new regulations to reduce risk-taking and prevent a repeat of the 2008 financial crisis prompt lenders to demand more high quality assets. In the U.S., banks have increased their holdings of Treasuries and debt from federal agencies to an unprecedented $1.99 trillion, Fed data show.
The competition for bonds, along with slower inflation and faltering growth, has helped keep debt yields worldwide low. That holds true even for the U.S., where the Fed is on course to stop buying Treasuries and mortgage securities this month as a precursor to raising interest rates from almost zero as soon as next year.
Yields on 30-year Treasuries fell as low as 3.05 percent yesterday in New York, down from about 4 percent at the start of the year and the lowest level since May 2013, according to Bloomberg Bond Trader data.
“There is less supply and more demand,” Guy Haselman, an interest-rate strategist in New York at Bank of Nova Scotia, one of the 22 primary dealers that trade with the Fed, said in a telephone interview. “Regulation is making it so that it is much more costly to hold something that has credit risk, or a credit rating less that AAA, and has rewarded banks for having more of their balance sheet holdings in Treasuries.”
Being crowded out by global central banks has pushed private investors into riskier parts of the fixed-income market. With central banks “soaking up” government bonds, investors have shifted their focus to corporate bonds, with company debentures making up $13 trillion of their $24 trillion of debt holdings, according to the JPMorgan report.
“The bonds that they do own now are more risky,” Thomas Byrne, director of fixed-income at Wealth Strategies and Management LLC in Stroudsurg, Pennsylvania, said in a telephone interview. “When you can’t get enough yield in Treasuries, you move to investment grade, junk and deep junk.”
The percentage of non-government bonds held by investors that aren’t banks is 17 percentage points more than the share of such debt in the entire bond market, according to the JPMorgan report. That difference was zero in 2009 and indicates that successive quantitative easing programs since then have made these investors, often unwillingly, become increasingly more overweight credit, the analysts wrote.
The increased investor base for corporate credit in the last five years has driven corporate borrowings, with outstanding company bonds increasing 59 percent since the end of 2008 to $9.8 trillion, Bank of America Merrill Lynch Index data show.
Speculative-grade companies have sold more than $451 billion in bonds worldwide are on pace to exceed last year’s record issuance of $485.6 billion, Bloomberg data show.
“People are just reaching for yield,” Lawrence McDonald, a chief strategist at New York-based Newedge USA LLC, said in a telephone interview. “As a result what you’ve seen is the disrespect of credit quality and traditional metrics of credit investing.”