Central banks and the world of bonds

21 July 2014

“We expect to see a lateral movement in terms of the compression of spreads and a marginal drop in rates over the next few months on international financial markets. This is nothing revolutionary on a market that is, all things considered, fairly stable, the result of dynamics that have already played a large part over the past three years”. This is how Kairos manager and bond specialist Rocco Bove sees the current scenario. “It means that the game we are now playing is residual, leading us to assume that gains are potentially limited. The world we now live in is one with ever lower volumes and a sharp push to keep interest rates in check, while a series of banking risk regulatory processes are underway, draining liquidity from the market”. In a situation like this, adequate liquidity and moderate volatility are hard to guarantee. Basically, we are looking at financial repression, which not only makes it impossible to escape from a situation of low interest rates on one hand, but also generates negative real rates on the other.

Despite some concerns, Bove confirms a certain dose of optimism, especially given the ECB’s announcement that it will begin Europe’s version of quantitative easing in September. “An enormous quantity of money will be injected into the system, starting with €400 billion, which, following the TLTRO formula, will be given to banks so they will in turn lend to businesses”. The real economy should therefore be the QE’s end beneficiary, although there are doubts as to whether the credit will actually reach its intended targets, as there are no real stringent obligations for banks. This means that banks could very well, at least in the beginning, decide to use the cash to acquire bonds, thereby postponing the injection of fresh liquidity into the real economy until “round two”, which is to say 2015. Economic estimates and forecasts for recovery in the year to come will be based – and to no small extent – on this dynamic.

Accordingly, the trend in interest rates and spreads is expected to be moderately calm, since they tend to move in line with the ECB’s measures and stance. And not only the ECB, as quantitative easing policies are presently all the rage among the world’s other major central banks as well. The first, and thus far the only, to abandon these policies has been the Bank of England, as its economic bail-out measures are to have reached their conclusion – so much so that the London area can already be seen overheating. A year ago, the Bank of Japan also resumed expansive policies, along similar lines as the Fed’s, which continues to maintain its dovish stance, but is close to ending the tapering of QE in the next few months.