Chart of the Week: Reduction in central bank purchases threatens higher interest rates

The chart of the week is from Ryan Connelly, Senior Analyst for Global Economics:

In 2015, 2016, and 2017, central banks around the world bought so many bonds that they actually bought more bonds that were sold by governments. This pulled down global interest rates – this is especially evident in 2016. Even though the Federal Reserve had ended its quantitative easing program, there was so much demand for government debt that it pulled down US debt.

 

In 2018, this will change. Governments will continue issuing similar levels of debt, but central bank purchases will dramatically slow. 2018 will be the first year since 2014 where the private sector will need to acquire more sovereign debt – and the lack of government demand should lead to an increase in bond yields. The process began in 2017, with much lower overall purchases, and rates increased as expected. There is a lot of uncertainty about how high rates will go in 2018. The consensus opinion for 10yrs in both the US and Germany are for moderate rate increases – 2.86% for the US, 0.83% for Germany by year end – but the ranges are very wide. Some forecasters see US and German yields going far higher (3.85% and 1.5%, respectively).

 

I think many market participants have become complacent about interest rate risk. Rates have been low for a long time, and inflation – a main factor in driving up nominal interest rates – has been very muted over the past decade. FSG is not forecasting a dramatic increase in interest rates or inflation this year in developed markets, but it is a risk that MNCs with substantial interest rate exposure need to consider. Where operations would be negatively impacted by a spike in financing costs, MNCs should consider locking in financing arrangements sooner rather than later.”


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