Mabrouk Chetouane
The end of forward guidance, geopolitical pressures, resilient economic activity, and growing financing needs: an explosive mix
The start of the conflict in the Middle East has been the catalyst for a resurgence of tensions in sovereign bond markets worldwide, which intensified in August following Treasury Secretary S. Bessent’s announcement of an increase in the cap on long-term bonds buybacks. In the absence of a budget surplus, these operations will be financed with short-term debt issuances. Beyond this “Operation Twist”, a term usually applied to Federal Reserve operations aimed at rotating its bond portfolio to influence the slope of the yield curve, the drying up of summer funding flows is compounded by other factors beyond the control of the U.S. executive branch.
The increase in borrowing costs on both sides of the Atlantic stems from a marginal reassessment of the inflation premium attributable to the ongoing conflict in the Middle East. Beyond this nominal effect, which has played a secondary role, the recent rise in rates is primarily attributed to a reassessment of the real cost of money. This reassessment can usually be explained by three factors: a more restrictive monetary policy stance, a more dynamic business cycle, or pressure on savings stemming from greater investment needs.
We are presently seeing all three of these structural factors at work. The gradual withdrawal by central banks from their usual practice of guiding market participants’ expectations regarding the future trajectory of their decisions has been perceived by the market as a form of monetary tightening. Global growth, driven by massive investments in technological transition and economic sovereignty, shows no signs of slowing down despite the energy shock and has surprised the market consensus. Finally, the emergence of new debt issuers, particularly U.S. technology companies seeking to finance their capital expenditure (Capex) needs is creating a new kind of crowding-out effect. Pressure on global savings, which are certainly available and abundant, is mounting as competition between public and private issuers to capture these savings intensifies, putting upward pressure on government bond yields
Beyond these systematic factors, idiosyncratic phenomena are accelerating divergences already at work. Bond market participants distinguish between issuers with responsible fiscal trajectories, aiming for consolidation through expenditure control or the generation of growth and those whose creditworthiness deteriorates as election dates approach or when proposed budget bills fail to reflect the fiscal discipline demanded by the global context.
By Mabrouk Chetouane, Global Market Strategist