A key dynamic that’s been holding down bond yields since the global financial crisis is poised to ease next year — presenting a test to riskier parts of the market, according to analysis by Oxford Economics.
In the aftermath of the crisis, banks and shadow financial institutions in developed economies sharply cut back their issuance of bonds, to the tune of about $4 trillion, according to the research group’s tally. That happened thanks to banks shrinking their balance sheets amid a regulatory crackdown, and due to a contraction in supply of mortgages that were regularly securitized into asset-backed bonds.
“Against stable demand for fixed-income securities, the large negative supply shock created an increasingly acute shortage of these assets,” said Guillermo Tolosa, an economic adviser to Oxford Economics in London who has worked at the International Monetary Fund. The impact of that shock was an “almost decade-long yield squeeze,” he wrote.
That compression “may start to ease in 2018,” Tolosa wrote in a report distributed Tuesday.
Using slightly different metrics, the chart above shows how the market for financial company debt securities in the Group of Seven nations shrank after the 2009 global recession, and now appears to have flat-lined. Continued demand among mutual funds, pensions and insurance companies for fixed income then created the opportunity for nonfinancial companies to ramp up issuance, Tolosa wrote — a dynamic also seen in the chart.
It’s one of a number of supply factors that have been identified explaining why bond yields globally remain historically low. Perhaps the most well documented one is the quantitative easing programs by the Federal Reserve, European Central Bank and Bank of Japan that gobbled up about $14 trillion of assets.