Surge of Inflows Leaves Global Bond Markets in a Sweet Spot

  • Investor demand has swallowed up fresh supply so far this year
  • Debt funds are still attractive relative to bank accounts

Everything’s coming up roses for the global debt market.

Surging inflows into bond funds are soaking up the swelling supply of new notes, flying in the face of speculation that a great rotation in asset allocation -- cash flowing into equities at the expense of fixed income -- would thwart debt securities this year. That should help anchor borrowing costs for companies and governments around the world even as analysts expect the Federal Reserve to gradually raise interest rates.

Investors added $9.7 billion to global bond funds in the seven days through May 3, bringing year-to-date inflows to $140 billion -- a figure that represents about 4 percent of assets under management -- Bank of America Corp. said in a report citing EPFR data. JPMorgan Chase & Co. says that new demand for bonds will likely outpace supply this year.

“The bond demand picture this year is overwhelmed by a surge in the buying of bond funds,” JPMorgan analysts led by Nikolaos Panigirtzoglou wrote in a note last week.

If the hot run in inflows is sustained, 2017 would see $700 billion of new money devoted to the asset class, outpacing last year’s $575 billion, according to JPMorgan. The bank’s measurements include all bonds, both corporate and government, except local-currency debt issued by emerging-market borrowers.

JPMorgan had previously projected supply would overwhelm new demand to the tune of $500 billion in 2017, forecasting a paltry $200 billion of inflows -- a figure comfortably breached this year already.

But why the relentless tide of money into bond funds at a time when global interest rates are rising and yields are still depressed by historical standards?

Analysts cite the tailwinds generated by strong returns on fixed-income products and the stubbornly low interest rates offered on U.S. bank deposits.

JPMorgan calculates that 100 of the biggest bond funds globally produced an average return of 2.3 percent between January and April, which on an annualized basis would be higher than last year’s 5.8 percent advance.

For now, other signals look bullish too. Strategists from Bank of America reckon U.S. investors are likely to remain cash rich in the coming months amid an uptick in coupon payments and redemptions -- helping to offset the threat of reduced foreign demand as government bond yields in Europe trend higher.

Lower debt issuance to pay for mergers and acquisitions has been offset by higher corporate refinancing activity, and bonds sold by banks to meet regulatory requirements. That spurred Wells Fargo & Co. last month to increase its forecast for U.S. investment-grade bond supply this year to $1.25 trillion from $1.2 trillion, in line with 2016’s record, after issuance rose 10 percent in the first quarter from a year earlier.

JPMorgan strategists are bullish on the supply/demand picture globally, projecting a $300 billion year-on-year decline in new-bond sales this year, led by a fall in U.S. agency and mortgage-backed obligations.

Next year, however, could see supply exceeding new demand in fixed-income markets around the world if the European Central Bank pulls back on monetary stimulus and the Fed shrinks its balance sheet, according to JPMorgan, which estimates the oversupply could reach $800 billion.

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