LONDON — Government bond yields are likely to rise in 2023 for “the wrong reasons”, according to Peter Twogood, chief investment officer at Embark Group, as central banks ramp up efforts to shrink their balance sheets.
Central banks around the world have shifted over the past year from quantitative easing — which has them buying bonds to raise prices and keep yields low, in theory lowering borrowing costs and supporting spending in the economy — to quantitative tightening, which involves selling assets to have the opposite effect, and more importantly So, curb inflation. Bond yields move inversely with prices.
Most of the movement in both stock and bond markets in recent months has centered around investors’ hopes, or lack thereof, of a so-called “pivot” from the US Federal Reserve and other central banks away from hawkish monetary policy tightening and interest rate hiking.
The markets enjoyed a brief rally over the past few weeks on the back of data indicating that inflation may have peaked in several major economies.
“Inflation data is great, my main concern next year remains the same. I still think bond yields will turn higher for the wrong reasons.” … I still think September of this year was a nice warning about what could happen if governments keep spending,” Toogood told CNBC’s “Squawk Box Europe” on Thursday.
September saw US Treasury yields surge, with the 10-year yield at one point exceeding 4% as investors tried to anticipate the Fed’s next moves. Meanwhile, British government bond yields have jumped so strongly that the Bank of England has had to step in to ensure the country’s financial stability and prevent a large-scale collapse of Britain’s final salary pension funds.
Toogood suggested that moving from quantitative easing to quantitative tightening (or QE to QT) in 2023 would push bond yields higher because governments would issue debt that central banks are no longer buying.
He said the ECB had bought “every European sovereign bond over the last six years” and “suddenly next year…they don’t do that anymore.”
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The European Central Bank has pledged to start unloading its 5 trillion euros ($5.3 trillion) in bond holdings from March next year. Meanwhile, the Bank of England has stepped up the pace of its asset sales and said it will sell 9.75 billion pounds of gold bonds in the first quarter of 2023.
But governments will continue to issue sovereign bonds. “All of this will turn into a market where central banks don’t buy it anymore,” he added.
Toogood said this change in issuance dynamics will be just as important as the Fed’s “pivot” next year.
“Have you noticed bond yields, do they crash when the market is down 2-3%? No, they are not, so there is something interesting about the bond market and the stock market and they are interconnected, and I think that was the theme of this year and I think we have to be careful.” him next year.”
He added that continued high borrowing costs will continue to correlate with the stock market by penalizing “non-profit growth stocks,” and driving rotation towards value sectors of the market.
Some strategists have suggested that as financial conditions peak, the amount of liquidity in financial markets should improve in the coming year, which could benefit bonds.
However, Toogood noted that most of the investors and institutions involved in the sovereign bond market have already moved in and re-entered, leaving little upside for prices in the coming year.
“Everyone joined the party in September and October,” he said, after holding 40 meetings with bond managers last month.
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