Liquidity conditions in bond markets are tightening as the US Federal Reserve and European Central Bank scale back the vast asset purchase programmes that were introduced in response to the financial crisis a decade ago.
Oxford Economics, the consultancy, estimates that European investors have spent about $500bn a year buying foreign bonds after the ECB’s asset purchasing programme led to supply shortages from debt issuers in the eurozone.
European investors have bought more than half of the bonds issued by US companies over the past four years and own almost 10 per cent of the outstanding stock of US fixed-income assets.
US investors, in contrast, have a significantly lower exposure to foreign debt securities after spending about $200bn a year on non-US bond purchases while the Fed pursued quantitative easing.
Reductions in cross-border purchases by European and US investors as a result of the quantitative easing retreat are expected to exacerbate upward pressure on sovereign bond yields and corporate bond spreads.
The US bond market could be particularly vulnerable, according to Guillermo Tolosa, an economist at Oxford Economics. This is because weaker demand from European investors is expected to coincide with an increase in the supply of US sovereign bonds to help fund the government’s rising budget deficit.
Bonds issued by US companies and agencies are also likely to suffer as demand falls from European investors.
These factors should support the euro and depress the dollar in coming years.
