By Dhara Ranasinghe

LONDON, (Reuters) – The most trusted group of bond buyers in the world, central banks, may reduce debt purchases by up to $2 trillion next year across four large advanced economies. This could lead to a significant rise in borrowing costs for many countries.

Central banks have successfully halted government spending for many years. But especially since March 2020’s COVID-19 pandemic, which erupted in March 2019, central banks have helped to stop a large portion of the market debt from hitting the market and prevented yields rising too much.

However, central banks could set up a plan for the unwinding of pandemic-era stimuli. This would make a lack of high-rated bonds in Europe possible.

JPMorgan (NYSE 🙂 predicts that the demand for central bank bonds in America, Britain, Japan, and Europe will decline by $2 trillion by 2022 after a $1.7 trillion decrease this year.

Although it does not mention the effect of bond supply, the report expects that U.S. and British 10-year yields will rise by 75, 45, 55 and 55 basis point respectively by 2022.

JPMorgan expects that global central banks will see a $3 trillion reduction in bond purchasing, translating to an average yield growth of 20-25 basis points.

Craig Inches of Royal London Asset Management, Head of Rates and Cash, said, “I’m not saying next year will be bond Armageddon. But you have a period when inflation is stubbornly high. Central banks are behind in terms of raising rates. At the same time, you’ve also got large net supplies.”

This is a very interesting mix of bond market strategies.

U.S. Federal Reserve plans to end its phase-out of $120 million monthly purchases on March. This month will see the end of 895 billion pounds ($1.18 trillion) of Bank of England bond-buying program. The Pandemic Emergency Purchase Programme of (PEPP), 1.85 trillion euros ($2.09 trillion) of European Central Bank will also expire.

Markets won’t disappear if central banks don’t change. In order to offset the loss of PEPP, the ECB will increase its current monthly stimulus by 40 billion euros. The Fed and BoE will also continue to inject funds from matured bonds into the market.

However, overall the effect is negative.

Britain may be the most affected market. ING projects that in 2022, private investors will need to absorb a net 110 Billion Pounds of gilts, compared with 14 billion Pounds this year. These figures are based on the BoE’s bond purchase of close to 170Billion pounds 2021.

Furthermore, the BoE will stop investing proceeds from matured debt after interest rates hit 0.5%. That level would be possible between mid-2022 and 2023. The BoE may decide to sell any bonds once rates exceed 1%.

According to RLAM’s Inches, gross UK government borrowing plans will result in an average of 120 billion pounds per year net issuance. This is a level not seen since 2011. Inches predicts that 10-year yields in the future will be doubled from 0.75% currently to 0.85% by 2022. (Graphic: British gilt yields over a two-year period, https://fingfx.thomsonreuters.com/gfx/mkt/zdvxoxjwbpx/gilts1412.PNG)

“NOT PRICED”

The contrast is stark with the situation a year back, when central bankers were busy printing.

According to Ralf Prusser (global head of rates research, BofA), yield premiums could rise by 20-30bps in the eurozone.

Preusser explained that markets will be correct when they price an end to all asset purchases in the next year. “The rate shock is even greater and could risk being a very substantial chunk of positive net issue that we would have to absorb first since the European sovereign debt crisis,” Preusser added.

He said, “Spreads across Europe aren’t priced for this.” (Graphic: Supply outlook from BofA, https://fingfx.thomsonreuters.com/gfx/mkt/gkvlglqzzpb/SupplyBofA1412.PNG)

France is particularly vulnerable. It pays a tiny 35 bps yield premium to Germany over France, which is less than a quarter the amount paid by Italy. Unicredit (MI) says France will still have the highest debt volume not covered under ECB purchases. The net amount of issuance is estimated at 120 billion euro in 2022.

Camille de Courcel (OTC) said the overall euro supply including European Union bonds will reach 157billion euros. This is the largest amount since 2015.

According to her, “The net supply picture will change significantly next year in the face of a strong deceleration in (central bank) purchases and considering that gross supply will remain relatively high,” she stated. (Graphic: Estimated ECB purchases versus net market issuance, https://fingfx.thomsonreuters.com/gfx/mkt/movanqbzrpa/SupplyUniCredit%201412.PNG)

The U.S. may have a lower supply.

According to ING analysts, the $1 trillion reduction in Fed purchases annually will be compensated by a $1.5 trillion decrease in Treasury net issuance. According to them, this means that overall net supply pressures will drop by $0.5 trillion.

Ten-year Treasuries should be capped by the perennial demand from overseas. A Reuters poll shows that end-2022 yields will hover around 2.08%. Banks expect about 2.25%. This is 85 basis points higher than the current rate, even with a Fed taper or three possible rate increases.