An explosion in crisis borrowing around the world has not yet given so-called “bond vigilantes” sleepless nights or spurred them to pick fights with all-powerful central banks.
Global indebtedness, as predicted by the Institute of International Finance, is set to reach $277 trillion by year-end — encompassing public, corporate and household debt, that figure has increased by $15 trillion this year.
Governments which have opened the taps to offset the pandemic damage to economies, accounted for 60% of the increase.
Another estimate from S&P Global put global debt at $200 trillion by year-end.
Investment Outlook summit last week took a relaxed view of this debt mountain.
Bond market vigilantes — a 1990s-era term for investors who punish profligate governments by demanding higher yields – appear calm about record-high debt and rock-bottom bond yields.
The main reason is simply that central bank bond-buying holds down long-term borrowing rates, ensuring governments can borrow more at affordable rates. And as long as inflation stays below roughly 2%, as it has for much of a decade, central banks will keep buying.
For many asset managers, much of the debt – especially bonds issued to tackle the pandemic – will not reappear on the market ever again as central banks simply hold them to maturity.
Jim Leaviss, public fixed income CIO at M&G Investment Management, predicts this sort of “deficits-don’t-matter” world view will become increasingly common.
“On the face of it, bond vigilantes ought to be worrying. One reason we don’t is that debt servicing costs are incredibly low,” Leaviss told the summit.
“But I’d also be surprised, if in my career, we will ever see the bonds bought by the BOE, Fed and other central banks get willingly released into the market,” said Leaviss. He expects bonds to “disappear into central banks balance sheets and quietly mature there.”
Eventually, central banks may opt not to reinvest the proceeds of maturing bonds, the first step towards withdrawing liquidity. But this would change if there were persistently high inflation as recent rises in U.S. Treasury yields attest.
But that is unlikely for many years. Meanwhile, the boundaries between monetary and fiscal policy continue to blur.
NN Investment Partners CIO Valentijn van Nieuwenhuijzen noted many central bank officials had made clear they viewed curbing debt costs as part of their financial stability role.
“Government debt will stay with us for ever. It doesn’t have to be repaid. They can (roll over and refinance) given the cost of debt servicing and the current mindset at central banks.”
For junk bonds and emerging markets, which lack a powerful central bank backstop, some defaults and demands for debt relief look inevitable.
IIF data shows more than $76 trillion in debt has been racked up across emerging markets, a sector where there have already been several defaults and debt relief exercises this year.
Corporate and household debt, excluding the financial sector, totals $80 trillion and $50 trillion respectively.
Even in the West, calls are mounting to write off student loans, for instance. Italy’s co-ruling 5-Star Movement in a blog said the European Central Bank should cancel COVID-era Italian debt it owns.
Rome quickly rejected that suggestion, showing policymakers remain wary of advocating outright debt monetisation – essentially printing money to buy government bonds.
But then, they may never need to.
“If the BOE says it’s cancelling its QE gilts, markets will say ‘hang on, has the UK turned into a banana republic?’ Whereas if you put it on the balance sheet for ever, no one will ever notice,” M&G’s Leaviss said.
But as government borrowing and spending rises, so does pressure on central banks.
Markets, which previously panicked at any hint of stimulus withdrawal, may react even more furiously should central bankers talk of offloading their bond holdings or just decide to stop reinvesting the proceeds.
Mike Riddell, head of macro unconstrained at Allianz Global Investors, said the U.S. Federal Reserve started unwinding its balance sheet in 2017 but stopped after a year as 10-year yields hit seven-year highs.
“This is the world that we’re in,” Riddell said, noting Japan’s experience. Decades of bond buying have left the BOJ owning roughly 45% of the market and buying equities. “This is the future direction for every other central bank.”