June is set to see the largest amount of net sovereign issuance in global bond markets so far this year. This comes at a time when economic data is casting doubt on the possibility of rate cuts, putting investors’ appetite for debt to the test.
BNP Paribas data indicates that net government bond supply for the United States, euro zone countries, and Britain is expected to reach $340 billion. This increase is driven by a decrease in redemptions and central banks reducing their holdings of government bonds.
While analysts anticipate that the market will be able to absorb this supply, it could potentially lead to higher yields and unsettle investors who were counting on rate cuts to fuel a bond market rally in 2019.
The recent weak U.S. Treasury auctions on Tuesday serve as an early indication that the market is struggling to maintain optimism. Economic data has prompted traders to push back their expectations of when central banks will start cutting interest rates, further adding to the challenges faced by the bond market.
According to Camille de Courcel, the head of G10 rates strategy for Europe at BNP Paribas, there is still a significant amount of supply that needs to be absorbed in the market. She noted that the euro zone is expected to have its second highest month of net issuance in June. Despite the European Central Bank potentially lowering interest rates and economies recovering, de Courcel expressed caution about buying longer-dated bonds in June due to the strong supply and the possibility of yields increasing. Developed market governments are borrowing substantial amounts to support their economies in recovering from the impacts of the COVID-19 pandemic and the energy crisis caused by Russia’s invasion of Ukraine. Furthermore, upcoming elections in the United States, Britain, and for the European Union’s Parliament are adding to the pressure to maintain spending levels.
Quantitative tightening, also known as the reduction of bond holdings by central banks, is currently taking place. The Federal Reserve has been allowing $95 billion worth of government and mortgage-backed bonds to mature without replacing them each month. However, this process is expected to slow down starting in June. Similarly, the Bank of England is actively selling debt back to the market.
Despite this, investors have shown a strong interest in stepping in. In March, Britain experienced record demand for an inflation-linked 30-year bond. According to BNP Paribas, euro zone countries have already sold approximately 53% of their debt for the year, taking advantage of investor appetite. This is an increase from 45% at the same time last year.
“It is quite surprising to see how well the increased net supply has been absorbed,” commented Michael Weidner, co-head of global fixed income at Lazard Asset Management. He noted that many investors are now attracted to higher yields after years of minimal returns, as well as the potential for price rallies when central banks begin their easing cycles.
The rise in net supply in June is primarily driven by a decrease in maturing bonds. As a result, investors have less cash available to reinvest in the primary market.
Weidner believes that this imbalance has not posed a significant issue in the past. He expects banks to take on a substantial portion of the gross supply, considering the higher redemptions in the following month. This allows them to set up the sale of the bond portfolio accordingly.
Investors are increasingly worried about the growing government debt levels worldwide, particularly in the United States. The country’s Treasury bonds are viewed as one of the safest assets globally. According to a report by the Congressional Budget Office in March, it is projected that U.S. public debt will increase from 99% of GDP this year to 166% in 2054.
Michael Goosay, the global head of fixed income at Principal Asset Management, highlighted that if deficits continue to rise at this rate, investors may demand higher risk premiums for lending, especially for longer-term investments. However, in the short term, central banks’ role as the buyer of last resort and concerns about economic slowdown and the need for policy easing are influencing investor behavior.