Tag Archives: government bonds

Japan Is Fast Approaching the Quantitative Limits of Quantitative Easing

Bloomberg, Apr 7, 2016

The Bank of Japan is running out of government bonds to buy.

The central bank’s would-be counterparties have become increasingly unwilling to sell the debt that monetary policymakers have pledged to buy, and the most recently issued 30-year Japanese bond didn’t record a single trade during a session last week as existing owners opted to hoard their holdings.

The central bank in the land of the rising prices sun has set a target of 80 trillion yen ($733 billion) in government bond purchases per year in its continued attempts to slay deflation, an amount that’s more than double the pace of new bond issuance planned by the Ministry of Finance and about 16 percent of gross domestic product.

Source: Bloomberg

But safe assets like government debt aren’t just attractive to central banks looking to force investors into riskier asset classes and push down the cost of borrowing or to pensioners looking for a reliable source of income—they’re also in high demand by financial institutions for use as collateral.

That’s because where there is a dearth of safe assets, there is also an incentive and tendency for them to be manufactured; that is, improperly labeled as such. Past results certainly haven’t been pretty.

As the Bank of Japan begins to rub up against the technical constraints of its asset purchase program, Jefferies Group LLC Chief Global Equity Strategist Sean Darby proposes a radical solution: consolidate some of the Bank of Japan’s existing holdings of debt into a perpetual bond—that is, one with no maturity and therefore no principal repayment—with a coupon of zero.

“There is a growing realization that there are effective limits to how much more Japanese government bonds can be acquired,” he writes. “The BoJ is approaching a shortage of Japanese government bonds for the central bank to buy, as commercial banks, pension and insurance funds have run down their holdings.”

Darby cited a working paper from the International Monetary Fund which concluded the collateral needs of financial institutions were such that the Bank of Japan might be forced to begin tapering its purchases of sovereign debt in 2017 or 2018, to bolster his case.

The thinking here is that as the Bank of Japan reaches the quantitative limits of quantitative easing, the issuance of such a perpetual bond that costs nothing to service would be a way to offer the government a blank cheque to proceed with fiscal stimulus such as boosting spending or cutting taxes.

The strategist believes the Bank of Japan will drop hints about its intention to pursue such a plan at its April meeting.

The Bank of Japan’s decision to shock investors and adopt a negative rate regime in January—one week after Governor Haruhiko Kuroda said such a move wasn’t needed at the time—was spurred by a desire to push yields at the longer end of the curve as low as possible in preparation for the consolidation of existing debt into a zero coupon bond, according to Darby.

“The authorities are attempting to push bond yields down below existing nominal GDP, so that the existing debt can be converted or ‘consolidated’ into a perpetual zero coupon bond presumably before any ‘tapering announcement,'” he writes.

Whether this extreme step will ever be taken—in particular on the timetable the strategist suggests (i.e. ahead of the elections scheduled for this summer)—is highly questionable.

But Darby’s suggestion does underscore that with Japan unable to declare ‘mission accomplished’ on its quest for reflation and a shortage of bonds looming, it’s time to consider Plan (perpetual) B.


Bond Market Sends Fed All-Clear to Raise Interest Rates

Bloomberg, Sep 8, 2015


* Investors accept Yellen’s plan for gradual, data-driven policy
* Big differences from central-bank tightenings in 2004, 1999

Janet Yellen has the fixed-incomemarket just where she wants it: ripe for the first increase in U.S. interest rates since 2006.

Just about every indicator is telling the Federal Reserve Chair a move at next week’s policy meeting would cause government bonds little disruption. Her guidance has money markets pricing an extraordinarily slow pace of tightening, volatility metrics show no signs of panic, and forwards indicate benchmark rates will remain contained.Differences between shorter- and longer-term yields are flashing a positive signal for the economy.

A green light from Treasuries is vital to avoid derailing the recovery that Yellen has nurtured because they help determine borrowing costs for businesses and consumers. Acting decisively now may even lend investors greater confidence in the outlook for growth.

“The debt markets have priced in a lot and it’s now time for the Fed to take advantage of that,” saidPeter Tchir, head of macro credit strategy in New York at Brean Capital LLC, which has clients ranging from hedge funds and pension funds to money managers specializing in fixed-income markets.

Benchmark Treasury 10-year note yields were at 2.18 percent at 9:39 a.m. in New York on Tuesday, versus an average of 3.17 percent during the past decade. Forward contractsforesee a gradual increase to 2.4 percent in one year, with yields only reaching 3 percent around a decade from now. That’s a boon for any money manager fretting about an end to the 25-year bull market in bonds.

“The 10-year Treasury is at a very comfortable point, with forwards showing even a Fed hike won’t move yields much higher,” Tchir said. “Once we get through the first increase, and see the economy can do fine, it will remove the looming worry.”

Forward Guidance

Bond investors have had plenty of time to get comfortable with the idea that interest rates are going to rise from near zero. As long ago as March, the Fedintroduced the possibility of a move in 2015. Policy makers said more recently they intended to act before year-end, assuming continued improvement in the labor market, as they were confident inflation would move back toward their 2 percent goal.

With the unemployment rate at a seven-year low, futures tradesare pricing in a 30 percent likelihood of an increase this month and 59 percent odds of a tightening before Dec. 31. The Fed will announce its next policy decision on Sept. 17.

Even when the Fed does move, communication tools such as officials’ estimates for the future evolution of interest rates and Yellen’s own press conference may help assuage market nerves.

“It’s not only about the move itself, it’s also about the statement,” saidChristoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion. If “the Fed makes clear that there is a lot of time until the next hike, then there might be some relief and that could be good news.”

Cautious Approach

Money-market derivativesindicate investors see an exceptionally slow pace of tightening. They show the fed funds rate will average just 0.60 percent one year from now. Assuming it trades close to the middle of the official band, that doesn’t even price in two quarter-point increases.

For the Fed to keep bond traders onside, it may need to persuade them this is an environment closer to the tightening cycle started in 2004 than the one begun in 1994.

Starting with a shift to 1.25 percent in June 2004, theFed raised rates by a quarter percentage point 17 times to 5.25 percent in June 2006. Helped by transparency in Fed decisions, fixed-income securities still managed positive annual returns between 2004 and 2006.

By contrast, the Bank of America Merrill Lynch U.S. Broad Market Index of bonds fell 2.75 percent in its worst-ever annual loss in 1994 as then-Fed Chairman Alan Greenspan surprised investors by almost doubling the benchmark rate.

The path to higher rates isn’t totally free of warning signs this time either. Emerging-market stocks and currencies are tumbling, while a surge in credit spreads and stock-market volatility has pushed Bloomberg’s U.S. Financial ConditionsIndex below zero for the first time in three years, indicating market conditions are becoming restrictive.

“Yes, they want to tighten and the market understands they want to tighten, but they do need to be a bit careful,” saidJeremy Lawson, chief economist in Edinburgh at Standard Life Investments, which manages about $380 billion. “The more important question is not what happens in the first day or the first week, it’s what happens over the medium term.”

Time to Move

For now, Treasuries at least are showing few signs of alarm. An August jump in Bank of America Corp.’s indexmeasuring projected swings failed to take it above this year’s high set in February, leaving it more than 12 percent below the average back through 1988.

And a widening gap since mid August between yields on five-year Treasuries and those with 30 years to maturity indicates the Fed can move without killing off the potential for inflation to eventually reach the central bank’s 2 percent target.

“Any time the Fed goes into a tightening cycle there are always very valid and very good arguments to not do that,” saidOmer Esiner, chief market analyst at currency brokerage Commonwealth Foreign Exchange Inc. in Washington. “If you wait until all signals are telling you to raise interest rates you’ve already missed the boat and it’s already too late.”


ECB Billions Can’t Save Euro-Area Bonds From Worst Quarter Ever

Bloomberg, June 30, 2015

The European Central Bank’s first full quarter of quantitative easing hasn’t stopped the region’s government bonds from heading for their worst performance on record.

The rout started in April after the ECB’s purchases helped send yields on more than $2 trillion of euro-area sovereign debt below zero, sparking an investor backlash against such meager returns given the region’s improving economic outlook. ECB President Mario Draghi added fuel to that fire this month when he said markets must get used to periods of higher volatility. The latest turmoil in Greece further undermined bonds from Europe’s periphery, even as it revived some demand for the relative safety of German debt.

Euro-area sovereign securities handed investors a 5.7 percent loss this quarter through June 29, according to Bank of America Merrill Lynch’s Euro Government Index, which tracks data back to the end of 1985. That was led by a 16 percent decline in Greek securities, with German bonds dropping 4.7 percent and Spain’s 6.4 percent.

“German 10-year bund yields went down to five basis points in April at the same time the ECB was throwing 60 billion euros a month at the market,” said Mark Holman, chief executive officer at TwentyFour Asset Management in London, which oversees about $8 billion. “We’ve seen better growth prospects, better economic numbers. Is that consistent with five basis point yields? Absolutely not.”

The ECB settled about 194 billion euros of public bond purchases between the program’s start on March 9 and June 26, it said on Monday.


Everything You Ever Wanted to Know About Greek Debt Relief: Q&A

Bloomberg, June 18, 2015

After months of talks, Greece says it won’t agree to any deal with its creditors that omits a commitment to debt relief.

The two sides are at loggerheads, with the debtor (Greece) claiming it won’t be able prosper with the current debt load. The creditors (the International Monetary Fund, European Central Bank and euro-area member-states) on the other hand, would still like to get repaid. Greece’s total public debt stood at 313 billion euros ($356 billion) at the end of the first quarter.

Here are some answers to frequently asked questions.

What does Greece want?

A deal that includes a “restructuring of the public debt in order to put an end to the vicious circle of the past five years during which the country had to continuously receive new loans to repay the previous ones.”

Like asking my credit card company to erase my balance?

Not necessarily. Greece has offered alternatives, including indexing repayments to growth, a temporary moratorium, and a debt swap.

What do creditors say?

After two rounds of debt relief in 2012, creditors said they would consider, if necessary, easier repayment terms on bailout loans, including cutting interest rates. The offer was conditional on Greece meeting certain conditions, including maintaining a budget surplus before interest payments.

Can Greece ask for more?

Creditors have said that more relief isn’t on the table before Greece complies with the terms attached to its emergency loans. They say that the most immediate priority is that Greece meets the conditions of the next bailout tranche disbursement to avoid default.

Why won’t the creditors cave?

While a concrete commitment to debt relief from the creditors would make it easier for Greece to approve a new agreement with austerity measures, the creditors have their own taxpayers to answer to.

Who is owed the most?

The European Financial Stability Facility, the euro area’s original crisis-fighting fund, which has lent the country 130.9 billion euros, is Greece’s biggest creditor.

Member states of the currency bloc are on the hook for 52.9 billion euros. Greece also owes the IMF about 20 billion euros.

Isn’t the ECB involved, too?

The ECB and the currency bloc’s national central banks are a special case. Together, they hold about 27 billion euros in Greek government bonds. In addition, they support Greek banks with 118 billion euros of liquidity, which isn’t currently included in Greek debt figures.

How much is owed other investors?

After a restructuring and a debt-buyback in 2012, private investors hold less than 40 billion euros in Greek bonds.

How onerous are the EFSF payments?

The interest it pays is about the same as the EFSF pays, and therefore similar to what a AAA-rated country would pay. Greece also doesn’t have to pay principal until 2023 and has an interest deferral. The average maturity of EFSF loans to Greece is about 31 years, with the last payment due in 2053, according to the EFSF’s website.

What about IMF loans?

The bulk of amortization payments that Greece has to make until 2019 are for IMF loans, which in principle can’t be restructured. The interest paid isn’t fixed, and depends on the amount outstanding and the length of time since the money was advanced. The average rate varies from about 3 percent to 4 percent.

OK then, what’s going to happen?

Both sides are engaged in what some have likened to a game of chicken and it’s unclear who will blink first. There could also be another way out. IMF chief economist Olivier Blanchard (yes, he’s a creditor) on June 14 suggested a compromise:

Greece could be asked to offer credible measures to reach the lower target budget surplus and “show its commitment” to a more limited set of reforms.

In exchange, the creditors would “agree to significant additional financing, and to debt relief sufficient to maintain debt sustainability.”



The Best of Times for Swedish Households as Riksbank Prints Cash

Bloomberg, May 25, 2015

Sweden's Riksbank Governor Stefan Ingves Interview

Sweden’s Riksbank Governor Stefan Ingves

Sweden’s households are probably feeling a lot better than the Riksbank policy makers who are struggling to re-establish their credibility on inflation.

Helped by a buoyant consumer, Sweden’s economy grew 0.6 percent at the start of the year from the end of 2014, when it expanded at the fastest pace in almost two years, according to a Bloomberg survey of 13 analysts. Gross domestic product grew an annual 2.9 percent, they predicted. Statistics Sweden releases the figures on May 29.

“The households that have jobs have more or less never had it as good,” said Magnus Alvesson, head of economic forecasting at Swedbank AB in Stockholm. “Low interest rates, low energy costs and low inflation translate into high real disposable incomes, while the employment development has continued to be strong.”

That’s a salve for the Riksbank, which is depending on economic growth to revive inflation in the largest Nordic economy. The bank lowered its benchmark rate first to zero in October and then in successive moves to a record minus 0.25 percent as it also announced a plan to buy as much as 90 billion kronor in government bonds.

Krona Falls

The moves, which have driven down the krona by 4 percent this year against a basket of currencies, could also help reignite exports, according to the analysts. The economy may also gain momentum from unprecedented stimulus by the European Central Bank.

“The development in Europe is particularly important and it’s pretty obvious that the economy has turned for the better in Europe,” said Andreas Wallstroem, chief analyst at Nordea Bank AB in Stockholm. “All cylinders will soon be running.”

Yet policy makers will need the faster growth to actually translate into faster inflation. They received an unwelcome reminder earlier this month on the struggles they face, when a report showed consumer prices unexpectedly fell an annual 0.2 percent in April. The bank targets 2 percent inflation.

Deputy Governor Cecilia Skingsley said in a speech on Friday that the bank was prepared to act again and that that it “certainly shouldn’t underestimate the risks of setbacks.”

The GDP report could even add to their woes, according to Wallstroem.

“One could envision a scenario where we will end up with high productivity growth in Sweden, which will push down cost pressure and thereby inflation,” he said.