Cross-border bond buying may tumble this year as QE unwound: Oxford Economics

London (Reuters): Global cross-border debt buying could fall by more than half this year from 2017 levels as the ECB looks to reduce its stimulus, exacerbating upward pressure on bond yields, especially in the United States, according to Oxford Economics.

The consultancy estimated in a note yesterday (4 June) that cross-border debt purchases would average $500 billion in 2018, compared with $1.2 trillion last year, with a disproportionate impact from the end of the European Central Bank’s stimulus program. The ECB is currently expected to wind up its quantitative easing (QE) program by the end of this year, likely prompting European investors to rotate back into domestic securities to the tune of up to 200 billion euros ($235 billion) a year, Oxford Economics said, while US investors’ cross-border buying is also seen declining.

“The consequences for global markets of an end to ECB QE will be much bigger than those associated with the end of the Fed’s QE,” it added. This is because shortages of euro zone debt caused by ECB buying forced European investors to venture overseas, buying an average $500 billion of foreign securities annually in recent years - making them the world’s largest cross-border bond investors. European buying of US debt had mitigated the impact of the US Federal Reserve reducing its own QE in 2014, but US investors are unlikely to pick up the slack from the ECB, OE said, for two main reasons.

Firstly, US overseas buying during the Fed QE period averaged just $200 billion a year - much less than European overseas buying of bonds during ECB QE.

Secondly, the US government and companies are also stepping up their debt supply.

“The expected greater (US) supply, and subdued portfolio growth, imply fewer foreign purchases and thus a more limited provision of liquidity to global markets,” OE wrote.

“The liquidity squeeze is large and could even have a macro impact sufficiently strong that it slows down the actions that drive the squeeze,” it added, in a reference to central banks’ policy tightening.

Other economies too look unlikely to pick up the slack in cross-border bond purchases.

While Europeans last year accounted for 46% of cross-border bond purchases, other developed markets bought just 14%, OE calculated. It added that emerging markets’ foreign debt buying was also not seen recovering to past levels.

US fixed income is most exposed to the “retrenchment” of cross-border liquidity, the note predicted, adding almost a tenth of the debt stock was held by Europeans, alongside 6% of emerging debt.

The rotation in European investors’ holdings would in turn benefit the euro, OE added.