What will happen when central banks stop buying government debt

© REUTERS / Rick Wilking

Central banks have been the biggest buyers in the world of sovereign bonds. However, not only could soon stop being buyers but become sellers, which would mark a substantial change in global markets, explains Jon Sindreu in his article for The Wall Street Journal.

However, according to the  average , investors have not agreed to what exactly could lead that change.

In part, the problem is that "there is no consensus on how stimulus policies, also known as QE [quantitative easing, QE] affected the public debt [bonds] in the past". Therefore, it would be "particularly difficult to assess what will happen when this change occurs."

Many believe that bond yields could rise and stocks fall; others even believe that there will be no effect. At the same time, experts suggest groups that are riskier investments such as corporate bonds (corporate bonds) and government debt of Italy, which "bear the brunt".

"However, the profitability of European corporate high yield bonds recently hit its lowest level since the financial crisis, a potential sign that the threat of reduced emissions [debt] has not yet affected markets "says the author.

This way, when you start this change, it is likely that fund managers ( 'money managers') are not prepared and markets can move quickly. 

In the summer of 2013, investors were spooked by the withdrawal of the stimulus program of the Federal Reserve (Fed, for its acronym in English). This generated a quick sale of bonds.

By buying bonds after the financial crisis of 2008 the central banks 'developed' sought decrease performance and thus redirect the money into riskier assets, thereby reducing financing costs for companies.

"If it is unclear what benefits we had in buying, it is unclear what will happen in the sale," admitted Tim Courtney, chief investment officer of Exencial Wealth Advisors, cited by Sindreu.

According to recently published data, public debt held by the European Central Bank are valued at $ 4.5 trillion, more than any other central bank. The US Federal Reserve and Bank of Japan have 4.4 trillion dollars each.

With the recovery of the global economy, investors believe that debt in Europe and the US has already reached its peak. US officials think about how to liquidate the portfolio that have remained constant since 2014.

It is also likely that purchases of government bonds and corporate bonds by the European Central Bank reduced this year after the victory of Emmanuel Macron, who promised to support companies in the presidential elections in France.

Several investigations estimate that these policies have reduced by 1% yields on sovereign bonds of 10 years in the US and the UK, and 0.5% in the euro area. However, the causes of this Economists believed that, in a matter of central banks, only its decisions on interest rates affect the economy are unknown. Yields were low because rates were falling, even negative in some cases. On the other hand, if investors think that the authorities will keep interest rates at zero short term over the next 10 years, they will buy sovereign bonds that are above zero. 

Also, some investors indicate that if quantitative easing policies work, will be a clear message to the markets of the commitment of central banks to keep interest rates low.

"If correct, the authorities may protect markets from a selloff, even if re-sell the bonds, as long as they commit to keeping interest rates low," explains Sindreu.

However, there is another danger. QE policy may generate a 'portfolio effect', which occurs when sovereign bonds become scarce. Many investors prefer to buy government debt, since it is safe and has high liquidity, says the author. 

So, whenever central banks take debt market, 'money managers' need to fight for what is, lowering yields. Any sale of a central bank would increase the value of shares, raising profitability.

In the US, if borrowing costs rise, there will be less pressure on the Fed to raise interest rates in the short term. According to Neil Williams, chief economist at the company's investment management Hermes Investment Management, the sale of one third of the portfolio of bonds the Fed would have approximately the same effect as higher fees by 3% from its current level - 1%-.

This, in turn, could alter US actions, which seem more expensive if the safest assets perform better, explained Mark Heppenstall, chief investment officer of Penn Mutual Asset Management.

However, said Fabio Bassi, chief strategist at prices JP Morgan Chase & Co., investors tend to pay even greater attention to the so-called 'flow effect' policy of quantitative easing, or, in other words, the impact they have daily purchases by central banks on markets.

Bonds are stored by banks, benefiting the market to them. If banks realize they can sell much of its reservation to central bank will be more willing to offer investors a better price for these bonds, says columnist. 

This effect is much stronger in the euro zone than in the US, according to an analysis of the Bank for International Settlements and the European Central Bank. Within 30 days following the announcement of quantitative easing, the impact was greater for the less liquid assets such as corporate bonds, or debt of weaker economies such as Italy.

The safest, meanwhile, government bonds were the least affected, with the exception of the first round of purchases by the Federal Reserve in 2008.

Thus, in the event that the European Central Bank stopped its monthly purchases of 66,000 million dollars, public debt and weaker corporate bonds will be most affected, says the author.

"If not done carefully, the transition could be extremely damaging," said Arnab Das, an analyst at Invesco.

https://mundo.sputniknews.com/economia/201705111069074266-economia-compra-reserva-europa-eeuu/