LONDON — Government bond yields are prone to rise in 2023 “for the improper reasons,” in response to Peter Toogood, chief investment officer at Embark Group, as central banks step up efforts to scale back their balance sheets.
Central banks around the globe have shifted over the past yr from quantitative easing — which sees them buy bonds to drive up prices and keep yields low, in theory reducing borrowing costs and supporting spending within the economy — to quantitative tightening, including the sale of assets to have the alternative effect and, most significantly, rein in inflation. Bond yields move inversely to prices.
Much of the movement in each stock and bond markets over recent months has centered around investors’ hopes, or lack thereof, for a so-called “pivot” from the U.S. Federal Reserve and other central banks away from aggressive monetary policy tightening and rate of interest hikes.
Markets have enjoyed transient rallies over the past few weeks on data indicating that inflation could have peaked across many major economies.
“The inflation data is great, my major concern next yr stays the identical. I still think bond yields will shift higher for the improper reasons … I still think September this yr was a pleasant warning about what can come if governments carry on spending,” Toogood told CNBC’s “Squawk Box Europe” on Thursday.
September saw U.S. Treasury yields spike, with the 10-year yield at one point crossing 4% as investors attempted to predict the Fed’s next moves. Meanwhile, U.K. government bond yields jumped so aggressively that the Bank of England was forced to intervene to make sure the country’s financial stability and stop a widespread collapse of British final salary pension funds.
Toogood suggested that the transition from quantitative easing to quantitative tightening (or QE to QT) in 2023 will push bond yields higher because governments can be issuing debt that central banks are not any longer buying.
He said the ECB had bought “each European sovereign bond for the last six years” and, “suddenly next yr … they don’t seem to be doing that anymore.”
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The European Central Bank has vowed to start offloading its 5 trillion euros ($5.3 trillion) of bond holdings from March next yr. The Bank of England, meanwhile, has upped the pace of its asset sales and said it is going to sell £9.75 billion of gilts in the primary quarter of 2023.
But governments will proceed issuing sovereign bonds. “All of that is going to be shifted right into a market where the central banks are notionally not buying it anymore,” he added.
Toogood said this modification in issuance dynamics can be just as necessary to investors as a Fed “pivot” next yr.
“You notice bond yields, are they collapsing when the market falls 2-3%? No, they will not be, so something is interesting within the bond market and the equity market they usually are correlating, and I feel that was the theme of this yr and I feel we’ve to be wary of it next yr.”
He added that the persistence of upper borrowing costs will proceed to correlate with the equity market by punishing “non-profitable growth stocks,” and driving rotations toward value sectors of the market.
Some strategists have suggested that with financial conditions reaching peak tightness, the quantity of liquidity in financial markets should improve next yr, which may gain advantage bonds.
Nevertheless, Toogood suggested that almost all investors and institutions operating within the sovereign bond market have already made their move and re-entered, leaving little upside for prices next yr.
He said that after holding 40 meetings with bond managers last month: “Everyone joined the party in September, October.”