SocGen: Get Ready For The Bond Market Crash
“Prepare for a serious hangover: there is more debt in the non-financial sector than ever before. Bond funds under management have tripled over the past decade, and duration has surged. The unwinding of this unprecedented exposure to rates will initially feed the sell-off and eventually stress the credit spread complex. As non-US borrowers struggle to roll a gigantic stock of US debt, the cross-currency complex will be a channel of stress. Expect the ex-US G4 curves to steepen further as term premia normalize. 2017 is a busy year for European politics, but 2018 will be the moment of truth.”
SocGen has published a rather shocking report this week on the state of the world’s debt and how, with inflation rising and political uncertainty growing, the unwinding of the global debt mountain will cause an unprecedented hangover for global markets.
Get Ready For The Bond Market Crash
The rising value of debt tied to the global economy has gone relatively unnoticed over the past few years as interest rates have been held at record low levels and central banks have been happy to pursue easy money policies. However, Socgen’s writes that this could all be about to come to an end. And it’s not just the volume of debt that’s a problem; the bigger issue is duration.
“Let us emphasise a not-so-trivial feedback loop: the surge in global debt over the past ten years will naturally make any bond sell-off more dangerous (default risk will rise), but the unprecedented build-up of both debt and duration exposure may also aggravate the bond sell-off initially, as the now much bigger bond funds suffer losses and withdrawals.”
SocGen’s analysts believe the party is over. After decades of falling yields, the consensus at the bank is that now bonds are no longer an attractive asset class and outflows will accelerate going forward. How big these outflows will be and when they will stop is hard to tell. SocGen points out that assets under management in bond mutual funds have about tripled in ten years while the market capitalization of the Barclays Global Aggregate Fund (IG) has doubled in ten years, to some $45 trillion. Duration too has considerably increased. The average duration of the Barclays World Bond Index (ex Japan) increased some 50% from 2008 to 2016.
There are five reasons why SocGen is calling the end of the bond bull market as we know it and all are related to improving growth/inflation figures. That being said, analysts at the bank also point out that due to the size of the world’s debt mountain, a fast increase in bond yields would probably cause much credit stress, and this negative feedback loop would likely cap the rise in bond yields. But for now, there is a perceived feeling that a tentative pick-up in global growth and a greater taste for fiscal expansion will boost inflation, which will reduce the real debt load. Here are the five reasons SocGen believes the bond bull market is coming to an end:
- Global growth bottoming out
- Real rates exposed to CapEx revival
- Inflation bottoming out too
- Financial repression is receding (policies that direct savings towards the government, at a cheap price – such as financial regulation tightening, negative rates and QE)
- Rates valuation remains stretched.
All in all, SocGen sees 10-year Treasuries approaching 3.0% in 2017, some 35bp above forwards with Bund yields approaching 1.0%, some 50bp above the 1-year forward.