JPMorgan Stares Into a $1 Trillion Bond Abyss and Is Bullish

Updated on
  • Paring of central bank stimulus seen weighing on demand
  • Banks, reserve managers and pensions likely to fill the gap

Bond markets will be staring into a $1.1 trillion hole in demand left behind by their biggest patrons, central banks, as the latter pare stimulus next year.

But don’t fear the fading monetary put.

Commercial banks, emerging-market reserve managers and pension funds are all set to plug the shortfall, according to JPMorgan Chase & Co strategists. They project that a voracious appetite for bonds will mop up issuance next year, erasing the supply-demand imbalance risk left by central banks, and keeping the bull run in global debt intact.

Basic math explains the relentless bond bull market

“The Group of Four central bank-related imbalance for next year’s global bond demand and supply is expected to be $1.1 trillion,” strategists led by Nikolaos Panigirtzoglou wrote in a recent note. “At face value this creates significant upside risks to bond yields into 2018.”

There’s no cause for alarm, the team concludes.

Commercial lenders are set to buy as much as $500 billion next year thanks to excess liquidity, according to the analysis. Emerging-market central banks, meanwhile, flush with capital inflows, look poised to snap up $330 billion, akin to the 2013 heyday in oil prices.

G4 pension and insurance funds, for their part, are likely to lock in equity gains and increase fixed-income allocations by $100 billion over 2017 levels to a whopping $600 billion, anchoring borrowing costs for companies and governments around the world. And for good measure: net issuance volumes are likely to be modest.

The bullish outlook contrasts with warnings sounded by Panigirtzoglou and his team this spring of a $800 billion oversupply risk next year. The change of heart has been spurred by enduring retail and pension appetite for bonds this year driven partly by the need for a balanced portfolio, a dynamic that’s also capping long-dated spreads. JPMorgan projections are comprised of emerging- and developed-market obligations, corporate and sovereign alike, except for local-currency notes in developing economies.

Still, Wall Street bears aren’t convinced by the case that new sources of demand will plug the monetary shortfall.

“At the very least, net developed market fixed income supply will increase meaningfully next year, and this means a smaller liquidity buffer to absorb bumps in the road,” Morgan Stanley strategists including Adam Richmond wrote in their 2018 outlook this week.

But the risk to the bond bull market could lie elsewhere, the JPMorgan strategists conclude.

“In all, there is no doubt that retail investors’ demand for bond funds is the wildcard for next year’s bond demand supply balance,” they wrote.

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