Yesterday the Bank of England (BoE) found itself unable buy enough long dated gilts as investors continue to cling on to developed government bonds of all varieties. Following the BoE’s decision to cut the UK base rate and expand its quantitative easing programme by £60bn it only managed to receive offers to purchase £1.12bn of gilts with maturities over 15 years versus their target of £1.17bn. At least part of the reason for this shortage of availability is the more illiquid markets over the summ er – indeed the ECB overbought in earlier months in expectation of such illiquidity but the recent post Brexit expansion of QE obviously had no such option. This prevailing shortage, versus demand, of government bonds looks likely to remain a prolonged dilemma for central banks and investors alike.
The US Fed holds around 20% of all (Federal) government debt, the BoE 25% and the Bank of Japan over 30% of their respective debts. Even the more recently embarked ECB QE programme has swallowed up 15% of German government debt and that is not even considering a number of these central banks moving to buy corporate debt. Narayana Kocherlakota a former FOMC member recently wrote how, “scarcity is not about supply alone. In the wake of the financial crisis, households and businesses are demanding more safe assets to protect themselves against sudden downturns. Similarly, regulators are requiring banks to hold more safe assets.” The ECB and BoJ (and now to some extent the BoE) continue with aggressive programmes of bond purchases. And although the Fed is no longer embarking on QE it continues to hold its stock and roll over the interest payments. Moreover Treasury bonds should also continue to experience a lack of supply as the US Treasury has opted to rely more on bills than bonds to finance the current deficit.
The natural result of this shortage of usual safe assets is of course for yields to remain low; resulting in some moving into other securities with low expected risk and others to reach for yield further down the credit curve. With $12-13tn of negative yielding debt extending to maturities past 10 years in Germany and 15 years in Japan some have flocked to government bonds from countries such as Spain and Italy yielding just under 1% and over 1% respectively for 10 year maturities. This might seem attractive compared to 0% or less yield - but only if they are indeed an equivalent low risk investment. However such debt for both countries reached yields of 7% during the Europe crisis of 2012 and both have high levels of government and overall net foreign debts. We do not believe that these are appropriate low-risk-low-yield alternatives and offer far too little to compensate for the obvious risks. Better to invest within net creditor nations that can afford to pay you back and simultaneously offer yields that are a multiple of what Spain currently offers.