The location of the world’s savings glut has already changed — less oil, more Germany and East Asia.
But what’s also changed is that, per BofAML, said glut is no longer getting recycled into fixed income with the same ferocity it used to be:
And that, they say, will have consequences:
As Chart 3 highlights the most significant structural change is that persistently large current account surpluses are no longer being recycled into the accumulation of central bank reserve assets, which back in 2004/05 caused the decline in long-term US rates that Bernanke commented on. Looked at this from the perspective of current account deficit countries: their deficits are no longer funded by the foreign official sector, but instead by the foreign private sector.
This raises two issues for bond markets:
1. With the accumulation of reserve assets no longer being the dominant counterpart to persistently large current account surpluses, the demand for fixed income is likely to have changed; and
2. The reason this has not been an apparent feature of the rates market is the fact that QE has hidden the shortfall in sponsorship from non-domestic investors.
Their point being that “without the support from monetary policy, the market would have had to face a very uncomfortable supply-demand imbalance thanks to the savings glut no longer being recycled into fixed income”. Which seems fair:
Finally, and as they say, the more relevant question is simply how the supply-demand balance to evolve from here:
On the demand side:
• The Fed has announced its intention to taper reinvestments starting at the end of the year. We expect a gradual reduction such that the Fed stops reinvestments by the end of 2018.
• The BoJ is currently buying at a run-rate considerably below the targeted JPY 80 tn balance sheet expansion, consistent with the logic of QQE with yield curve control.
• The ECB has set in motion a meaningful taper already and we also expect the ECB to conclude the purchase of government bonds sometime next year.
• The BoE ended its QE programme in Q1. We do not expect any renewed QE buying, but reinvestments are expected to continue.
On the supply side, the expected size of the US deficit is clearly a function of the Trump administration’s fiscal plans near term, and in particular its use of dynamic scoring. Longer-term, however, CBO estimates show a considerable deterioration regardless. Elsewhere we are looking for few meaningful changes in the fiscal stance one way or the other. For the purposes of our 2018 estimates, we ignore the risk of a deterioration in the US deficit on the back of tax reforms or infrastructure spending. We also assume that reinvestments of the Fed’s balance sheet will continue at a gradually declining pace until the end of 2018. Our estimates could therefore be viewed as a lower bound for the supply that will have to be absorbed by the private sector.
We therefore see a considerable gap opening up (Chart 6). 2016 has likely marked the peak in QE buying. For the gap to be filled, we either need to see a return to rapid reserve accumulation or the private sector to step up. For reserve accumulation to pick up materially requires either considerable oil price recovery, or a return to a much more mercantilistic exchange rate policy by emerging market central banks. The onus, in our view, therefore is on the private sector. However, foreign private sector demand for fixed income is above its 13y average already. It therefore seems safe to assume that for the private sector to fill the gap, yields will have to rise.
Some problems are designed to fix themselves.
Corporate surpluses are contributing to the savings glut – FT Wolf
Michael Pettis explains the euro crisis (and a lot of other things, too) — FT Alphaville
Global macroeconomic imbalances are shrinking (and not) – FT Alphaville
That euroglut outflow and the real Japanisation of Europe -FT Alphaville
Behold the euroglut – FT Alphaville