$6.7 trillion cash cushion may boost bond markets

LONDON • If you are worried the US Federal Reserve will topple the debt markets, consider this: there has rarely been so much cash available in the world to buy such assets.

While the prospect of higher US interest rates sent bonds worldwide to the biggest quarterly loss, JPMorgan Chase says the excess money in the global economy - about US$5 trillion (S$6.7 trillion) - will support demand and bolster asset prices. Since 1990, there have been four periods when households, companies and investors held such a surplus.

Each time, markets rallied.

"The world is awash with unprecedented excess liquidity," said Mr Nikolaos Panigirtzoglou, a strategist at JPMorgan. "Fed tightening won't change that."

The cash cushion has surged in recent years as the world's central banks injected trillions of dollars into the financial system to jump- start demand after the credit crisis. Now all the extra money may help extend the three-decade bull market in bonds even as a stronger US economy pushes the Fed closer to lifting rock-bottom rates.

Bonds suffered a setback in the last quarter as signs of inflation in both the United States and Europe sparked an exodus after yields fell to historical lows.

They lost 2.23 per cent, the most since at least 1996, data compiled by Bank of America shows.

Worries over Greece's financial ruin and China's stock-market meltdown have pushed investors back into the safety of debt securities.

Yet, Wall Street is still bracing itself for a sell-off, especially in US Treasuries, once the Fed moves to raise rates that it has held near zero since 2008.

Yields on the 10-year note, the benchmark used to determine borrowing costs for governments, businesses and consumers, ended at 2.4 per cent last Friday. Forecasters surveyed by Bloomberg say yields will approach 3 per cent within a year. Although JPMorgan provided plenty of caveats, the firm's analysis suggests it might not play out that way.

Helped by bond-buying stimulus in the US, Japan and Europe, and increased bank lending in emerging markets, the amount of cash in circulation now totals US$67 trillion globally, compared with about US$62 trillion of estimated demand, data compiled by the New York-based bank shows.

While the surplus has fallen from a record US$7 trillion in July last year, it is still more pronounced than the three previous periods - 1990-1995, 2002-2004 and mid-2009 to mid-2010 - when cash was abundant and asset prices soared. And if you compare that amount to the market value of bonds and stocks, the ratio is still well above pre-crisis levels.

"We are not worried about the end of the bull market," said AllianceBernstein global head of credit strategies Ashish Shah. "There is good liquidity overall that needs to be put to work."

One reason for the bullishness is the US economy is not generating the kind of wage growth and inflation that would lead investors to abandon bonds, even as hiring climbs and business confidence grows. Meanwhile, Europe is struggling to boost growth and inflation, while the International Monetary Fund warned that financial market turbulence from China to Greece poses a risk to global growth.

Mr Jim Leaviss, a London-based money manager at M&G Investments, said: "If you want to get really bearish on bonds, you will have to start thinking about yields and Fed funds rate going back to similar levels they were pre-crisis, but that is unlikely to be the case."

Before the financial crisis, rates exceeded 5 per cent.

Yet with yields still so low, bonds won't provide enough compensation for investors as the economy accelerates and the Fed starts raising rates, no matter how much excess liquidity there is, according to Mr William O'Donnell, the head US government-bond strategist at RBS Securities.


A version of this article appeared in the print edition of The Straits Times on July 14, 2015, with the headline '$6.7 trillion cash cushion may boost bond markets'. Subscribe