Back in March, we got a look at just how absurd the dynamic between central banks and the market has become when the Osaka circuit breaker was tripped after the bid-to-cover in a Bank of Japan bond buying operation jumped to 3.58 from 2.93 the previous week.
Basically, everyone had rushed in the previous day in order to frontrun the next day’s central bank operation and then, when it became apparent just how strong the selling impulse was (as reflected in the bid-to-cover), everyone panicked, sending yields up 8 bps and triggering the breaker so everyone could “calm down.”
(Chart: Bloomberg)
Well, it wasn’t 10 days later when the entire dynamic reversed itself. Yields on 10Y Japanese government bonds fell 8 bps after the bid-to-cover at another BoJ bond buying op came in at just 1.53. No one wanted to sell, which in turn triggered panic buying.
See why that’s so silly? The market moves had absolutely nothing to with anything other than traders trying to game the central bank purchases.
We bring up this amusing bit of “ancient” history because on Tuesday, the Bank of England ran into trouble trying to buy gilts. What they wanted to do was buy £1.17 billion in bonds with maturities 15 years and out. What they got were offers to sell £1.12 billion. In other words: failure to launch. Here’s the schedule, via FT:
“For the next three months, the BoE plans to buy gilts on Monday, Tuesday and Wednesday, dividing purchases into maturity brackets of three-to-seven years, seven-to-15 years and over 15 years.”
As you might imagine, that little snafu helped send yields on UK 10s and 30s to record lows. “You’d understand why investors might not be keen to offload longer bonds -- if you are looking for yields that’s the only place on the curve to be,” SocGen’s Jason Simpson, told Bloomberg. “It is a bit of a surprise that this went uncovered in the first week of the operation, goodness knows what happens next week.”
Yes, “goodness knows.” The gilt 2s-3s curve is now inverted for the first time in eight years.
“The market is watching this sovereign bond-buying program closely,” Credit Agricole’s Mohit Kumar said on Monday. “While it’s likely to lower longer-maturity yields, it’s not obvious at this point, on its own, how effective it will be given yields are already very low.”
Meanwhile, the pound got pounded as traders took the BoE’s Ian McCafferty at his word when, in an Op-ed for The Times, the policymaker said the following:
"Bank rate can be cut further, closer to zero, and quantitative easing can be stepped up.”
Sure, it “can be stepped up.” Assuming there are any willing sellers.
As for the BoE’s corporate bond buying program, the market is already pricing in the bazooka and, at least according to BofAML, you’d be wise not to fight it:
“Central banks can take corporate bond spreads tighter. Last Thursday and Friday, during what was effectively the first day and a half after the Bank of England’s announcement of corporate QE starting in September, sterling HG corporate bond spreads on our index tightened 15bps, or nearly 10%, to 144bps. This is especially impressive because only 40% of the index (£150bn) is even eligible for BOE purchases. We find that, by deflating sterling and euro credit spreads, the BOE and ECB corporate bond QE programs are creating a lot of attractive relative value in the dollar market. Specifically, for European issuers that have outstanding bonds in both sterling and dollars, on a currency hedged basis we find that spreads are now nearly 30bps wider in USDs than GBPs. For issuers that have both euro and dollar bonds outstanding the USD tranches currently offer spreads that are 45bps wider than their euro counterparts. While US issuers are also richening significantly in sterling and euro, current pricing indicate little difference in spreads between dollars and European currencies. Regardless the relative cheapening of dollar spreads in general is bullish as investors reach for yield.”
(Charts: BofAML)
Right. In other words, you want to be in US investment grade credit. Of course the very fact that everyone knows that portends an influx of buyers which will in turn drive down yields there too. Here’s BofAML again:
“Around 45% of the global fixed income market is now ‘compromised’ by central bank buying. The true winners will therefore be the debt markets that are untouched by central banks, and investor money will ultimately gravitate here in search of better liquidity and better value. We think US IG bonds stand to benefit (again) from the BoE’s policy.”
Want to see what it looks like when investors frontrun central banks? Have a look at this chart of inflows into European high grade corporate debt:
(Chart: BofAML)
That’s the largest inflow in history.