LIVE MARKETS-Changing buyer mix leaves very long government bonds vulnerable to volatility

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CHANGING BUYER MIX LEAVES VERY LONG GOVERNMENT BONDS VULNERABLE TO VOLATILITY

Government bonds with maturities over 10 years are likely to remain volatile and see further periods of yield increases as the investor mix for the bonds changes towards more price-sensitive and less reliable buyers, according to Capital Economics.

Very-long-dated debt has come under pressure at times this year and episodes like this may become more common without fiscal reforms, which seem unlikely, Thomas Mathews, head of markets, Asia Pacific, at the firm, said in a report.

A main reason for this is that demand for the debt from its traditional buyers has declined, “and we doubt it’s coming back.”

Mathews notes that central banks have stepped back from government bond markets as they normalize monetary policy and their balance sheets. And while other investors have stepped up to fill this void, it hasn’t been the traditional buyer of the debt.

Pensions haven’t grown their government bond holdings in major economies by much, and with asset growth slowing and the ongoing rise of defined contribution funds, which don’t hold as many longer-dated bonds, this demand is unlikely to be as significant as it previously was.

Life insurers, which have also been a major source of demand for very-long-dated bonds, may not pick up the slack, Mathews added.

Other big buyers include reserve managers, banks and non-pension investment funds. “But, most of those would either prefer to buy shorter-dated bonds, aren’t buying in significant quantities, are quite sensitive to the price, or some combination of these three.”

Greater reliance on these investors has coincided with yield increases in very-long-dated bonds in many places. Governments could adjust their issuance to prioritize shorter-dated debt, but the required adjustment is often large.

“That suggests to us that, at best, volatility is likely to remain high at the very long end as debt management offices attempt to adapt to the new demand reality. And at worst, yields of very-long-dated bonds could rise quite a bit higher as price-sensitive buyers continue to play a greater role in the bond market,” the firm concludes.

(Karen Brettell)

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