Savings Glut And Current Account Surpluses Are Bad News For Bond Yields

A global savings glut and lack of central bank intervention in fixed income markets will lead to structurally higher real yields for fixed income going forward argues Bank of America’s Rates Strategist Ralf Preusser in a research note issued earlier this week.

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Large Current Account Surpluses Savings Glut Bad For Bond Yields 

According to Preusser’s findings, since 2006 have become more concentrated with the ten largest current-account surpluses accounting for 84% of all current account surpluses in 2016, compared to 86% for 2006. However, this aggregate current-account surplus as a share of world GDP has been broadly stable over the last five years. What’s more, the aggregate current-account surplus remains well below the peaks seen in 2006/2007. 

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• US Mercantilism Is Not Good For The Trade Deficit

So, while it is true that trade imbalances have become more concentrated, the global savings glut is well below peak levels and has not been increasing since the financial crisis. What’s striking about these figures is the “qualitative changes in the composition of the savings glut have had on the accumulation of claims on the rest of the world.” As Preusser explains:

“Remember that a current account surplus has to be matched by a capital account deficit, and therefore the accumulation of net external assets. It was this effect that Ben Bernanke analyzed in 2004 when he coined the term “savings glut” and which he used to explain the secular decline in long-term rates.”

“The most significant structural change is that persistently large current account surpluses are no longer being recycled into the accumulation of central bank reserve assets, which back in 2004/05 caused the decline in long-term US rates that Bernanke commented on.”

This means that the countries with large current account deficits are seeing their deficits being funded by the foreign private sector, not the official foreign sector. This raises two big issues for bond markets:

“1. With the accumulation of reserve assets no longer being the dominant counterpart to persistently large current account surpluses, the demand for fixed income is likely to have changed; and

2. The reason this has not been an apparent feature of the rates market is the fact that QE has hidden the shortfall in sponsorship from non-domestic investors.”

As shown in the charts below, even when taking into account the demand for debt securities by foreign private investors, the savings glut is no longer being recycled into fixed income. The decline in demand has been hidden by the considerable amount of net supply taken out of the market by QE

Put all of this together, and it’s clear that without the support of monetary policy, the market would have had to face a considerable supply-demand imbalance. It remains to be seen how the fixed income market will cope now that QE is being tapered out. The increase in supply will have to be absorbed by the private sector. This “argues for structurally higher real yields in equilibrium.”