Column: Undermining half of the 30-year bond bull run

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LONDON, July 15 (Reuters) – A more insular global economy will come at a high price if the era of global currency stockpiling follows globalization in reverse.

By some estimates, this could risk up to half of the bond rally of the past 30 years and usher in a prolonged period of higher borrowing costs for all.

It doesn’t take much imagination to concoct a scare story about interest rates right now. Betting on higher borrowing costs right now hardly requires a PhD in economics.

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Inflation and interest rates are soaring after the pandemic, further boosted by energy and commodity price shocks caused by the invasion of Ukraine. The U.S. Federal Reserve is shifting into high gear to contain consumer price rises that have reached their highest level in 40 years and the dollar’s exchange rate is electrified across the world.

Guessing how this will play out over the next 12 months or so requires the dexterity of everyone from Fed watchers to Kremlinologists. While they achieve this, financial asset prices are falling everywhere – with few places to hide.

But the final landing zone for the global economy and global asset prices depends to a large extent on the extent to which decades of globalization of trade and investment, which have highlighted one of the booms financial markets in history by pooling global savings into “safe” bonds, has already peaked and is now in irreversible decline.

Many economists are calling time on this period after four years of serial disruption – from Washington’s trade wars under Donald Trump, to COVID lockdowns or health protectionism, and now a revival of Cold War politics and a realignment of alliances economic after Russia’s attack on Ukraine.

The precise cost is a fuzzy concept. But some are trying it.

In their annual Equity-Gilt Global Asset Price Research study published this week, Barclays economists dwell at length on the topic of ‘de-globalization’ – in particular the reshaping of cross-border supply chains, investments and borrowings in the midst of a wave of ‘sur-shoring’, ‘near-shoring’ or even ‘friend-shoring’.

They describe an ‘era of instability’ ahead as we bid farewell to the ‘great moderation’ in prices, wages and interest rates associated with years of expanding trade and access to global markets. labor – and also a potential resumption of macroeconomic volatility due to the return of clumsy inventory management after years of “just-in-time” supply chains and shipping.

But in a special chapter on a possible spike in central bank hard currency reserves – one of the most obvious components of the so-called “global savings glut” that is depressing borrowing rates for decades – the study gives an estimate in basis points of the type of risk to come.

The article, authored by Themistoklis Fiotakis, Marek Raczko and Sheryl Dong, details how reserve building was a function of decades of trade, investment and financial globalization. Their model concluded that banking more than half of these cash reserves in US government debt has lowered 10-year Treasury yields by about 300 basis points since 1990.

That’s half of the decline in 10-year yields that peaked at almost 9% 32 years ago. And given that the inexorable decline in long-term yields has been a key factor in supporting credit and other interest-rate-sensitive asset values ​​during this period, this type of impact has been profound.

Global Foreign Exchange Reserves and US Treasury Yields
Barclays graph on the impact of reserve building

‘DECUMULATION’

The Barclays team has floated the idea that Western governments’ decision to freeze around half of Russia’s central bank reserves as a sanction against Moscow’s invasion of Ukraine in February would mark a security overhaul and whether to continue decades of this strong accumulation of reserves.

Much of the investor concern over the past few months has centered on the idea that countries that felt their reserves could be similarly confiscated would engage in rapid diversification away from the U.S. dollar, which still represents nearly 60% of the world’s stock of nearly $13 trillion.

But Barclays believes there is no viable alternative to the dollar as the dominant currency, other G10 countries have also agreed to freeze Russian reserves anyway and, instead, reserve managers could over time choose to curb reserve building entirely – as renowned reserves expert Barry Eichengreen at the University of California, Berkeley told Reuters in March. Read more

The end of reserve building would have profound implications for how countries would manage their likely more volatile exchange rates and dependence on the Western world for export demand – as well as huge changes in the how domestic firms would access foreign borrowing and foreign investment.

But if greater use of capital controls and regional or hub-like trade links were adopted instead, then a gradual reduction in these savings reserves could occur – even if it rapidly worsens financial “deglobalization”. in the process.

Focusing on the direct impact on US Treasury borrowing rates, Barclays’ model suggests that every $1 trillion increase in dollar foreign exchange reserves reduces 10-year yields by 55 basis points over the long term. term, half of which is visible in the first 10 months.

“While our model shows that the direction of returns would not have changed over time, it is possible that much of the decline is related to excess savings outside the United States,” adds the log. “And as such, the decumulation of reserves should also impact yields.”

Ending the build-up of reserves is of course not the same as selling those assets. But even a halt in the accumulation removes a long-standing outsized supply on “safe” assets and could provide another nail in the coffin of the decades-old bull market.

Share of the US dollar in world foreign exchange reserves

The author is Finance and Markets Editor at Reuters News. All opinions expressed here are his own.

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Written by Mike Dolan, Twitter: @reutersMikeD Editing by Susan Fenton

Our standards: The Thomson Reuters Trust Principles.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias by principles of trust.

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