1. Art and Diseño

Asset management
2 February 2015
Economist Insights
Space saving
Low interest rates mean that governments’ borrowing
costs have fallen, so they are making implied savings
simply from not having to pay as much in interest payments.
The low rates may be due to the dominance of priceinsensitive buyers of government bonds. With the ECB
embarking on its QE programme, if there are limited
sellers of government bonds then bond yields could fall
by more than is currently priced in.
Joshua McCallum
Head of Fixed Income Economics
UBS Global Asset Management
[email protected]
Gianluca Moretti
Fixed Income Economist
UBS Global Asset Management
[email protected]
The recent bond rally has been great for anyone who holds
government bonds. But it has also been great for anyone
who wants to sell government bonds. And the biggest sellers
of government bonds are the governments themselves. The
central banks can be thanked for this bonanza due to their
programmes of quantitative easing (QE). Some economists
refer to QE as ‘quasi-fiscal’ policy because of the fiscal benefits
it brings to governments.
Italy in particular is a big beneficiary, with interest savings of
over 0.6% of GDP. This is a lot compared to Italy’s planned
fiscal tightening of about 1% of GDP. So Italy has arguably
achieved more than half of its planned fiscal tightening
simply because borrowing costs have fallen. The lower
interest payments give Italy ‘fiscal space’ which it can use to
either cut debt faster,
or reduce the amount of austerity.
The benefits from lower interest rates can be measured
by looking at how much higher the interest payments for
government debt would be if interest rates had not changed
over the last year. The lower interest rate will not affect all
government debt, only debt that is rolled over into new
bonds or is newly issued to cover the ongoing deficit. But
that can still be a pretty substantial amount (chart 1).
In other countries the benefits are not so large, but Spain will
still find its life noticeably easier as a result. The benefits to
countries such as Germany and France are far less because they
are issuing less debt. It is also less important to them because
they are not planning any fiscal consolidation this year.
Chart 1: Fiscal space
Planned fiscal consolidation in 2015 and implied savings from lower
interest rates, % of GDP
1.5
1.2
0.9
Outside the Eurozone interest rates are also low. The US is
undertaking a fiscal tightening so lower interest payments
would be welcome. But the US Treasury still insists on issuing
most of its debt with quite short maturities, where the shift
in the interest rates curve has been much smaller. Although
the UK has traditionally issued longer-dated debt, last year
much of the debt it issued was of much shorter maturity.
Given the size of fiscal tightening planned in the UK for this
year, maybe the UK government should think about issuing
more longer-dated bonds.
0.6
0.3
0.0
-0.3
Germany
France
Fiscal consolidation
Italy
Spain
Interest rate saving
US
UK
Source: Bloomberg Finance L.P., IMF, UBS Global Asset Management. Note: interest
rate savings are calculated by taking gross issuance in 2015 and assuming the same
maturity distribution as 2014, then applying the change in borrowing costs over the
last 12 months. The calculations also assume that the interest rate for each maturity
remains unchanged at the level of the end of January.
However, this interest rate saving is only the indirect effect of
QE. There is a more direct effect that will benefit governments.
Because of the way QE is designed in the Eurozone, the national
central bank balance sheets will take the majority of the exposure
to potential losses on the bonds they purchase. However, this
means that they will be keeping most of the coupon payments
they make on their bonds. If, as happens with the Securities
Markets Programme, those coupon payments are returned to the
government, then the saving of public finances could be at least
an additional 0.3-0.4% of GDP in countries like Italy and Spain.
Who will sell?
The government bond market is not a normal market, at least
not anymore. In most securities markets, investors buy the
securities because they like the expected return relative to the
expected risk. Yet there are many buyers of government bonds
who do not care about the returns.
A foreign central bank that wants to hold EUR-denominated
foreign exchange reserves buys government bonds because
they are safer than other assets and are in the right currency.
The returns are a secondary consideration. Regulations require
banks to hold a lot of government bonds as part of their capital;
the banks have no choice so the return is not even considered.
Pension funds and insurance companies have to ensure that
their assets match their liabilities, and with many long-term
liabilities they must buy the only source of long-term ‘safe’
assets around: government bonds.
Chart 2: Insensitive
Holders of Eurozone government bonds, Q3 2014
Foreign 31%
Banks 30%
Pension & insurance 20%
Investment funds 11%
Others 6%
ECB 2%
For the sake of argument, assume that about half of the
foreign holdings of Eurozone government bonds are with
foreign central banks (based on IMF data on declared
currency reserves). Assume also that banks and pension
funds are unwilling to sell their government bonds. That
leaves only about a third of Eurozone government bonds held
by willing sellers. This is quite a challenge when the ECB is
planning to buy over a third of that remaining amount. In line
with the European Court of Justice opinion on the Securities
Markets Programme, the ECB is keen to avoid distorting the
markets so it has limited its purchases of any single issuance.
But the effective, or liquid, market might be so small that
distortions are inevitable.
When there are fewer sellers relative to the amount being
bought, prices should rise. Unless the price-insensitive buyers
turn out to be more willing to sell (for example, banks might
have more government bonds than they need), this really
suggests that bond prices should rise (yields should fall).
The market may already have spotted this mismatch, which
would help explain why Eurozone bond yields continue to fall
despite the uncertainties about Greece. Or the ECB may find
that it ends up paying over the odds for increasingly scarce
government bonds.
Governments in the Eurozone may be benefiting from extra
fiscal space thanks to the ECB’s QE programme, but the
ECB itself may find it has very limited space within which
to conduct its QE programme. But at least the ECB can be
reassured that the less space it has (and the lower it pushes
bond yields), the more space it creates for the governments.
Source: ECB Monthly Bulletin, UBS Global Asset Management
The common theme is that all of these buyers are price-insensitive.
The majority of the government bonds they hold would have
been bought even if the yield were zero (or even negative).
Now the ECB is embarking on QE and is planning to buy about
12% of the Eurozone government bond market over the
next 18 months. But who will want to sell the bonds to them
(chart 2)? Foreign central banks want to keep their reserves.
The banks need to meet regulatory requirements. Pension
and insurance funds need to match their liabilities. That leaves
investment funds, foreign non-central bank holders and the
‘others’ (households and non-financial corporations) who may
be willing to sell their government bonds.
The views expressed are as of February 2015 and are a general guide to the views of UBS Global Asset Management. This document does not replace portfolio and
fund-specific materials. Commentary is at a macro or strategy level and is not with reference to any registered or other mutual fund. This document is
intended for limited distribution to the clients and associates of UBS Global Asset Management. Use or distribution by any other person is prohibited. Copying any part of this
publication without the written permission of UBS Global Asset Management is prohibited. Care has been taken to ensure the accuracy of its content but no responsibility
is accepted for any errors or omissions herein. Please note that past performance is not a guide to the future. Potential for profit is accompanied by the possibility of loss.
The value of investments and the income from them may go down as well as up and investors may not get back the original amount invested. This document is a marketing
communication. Any market or investment views expressed are not intended to be investment research. The document has not been prepared in line with the requirements
of any jurisdiction designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment
research. The information contained in this document does not constitute a distribution, nor should it be considered a recommendation to purchase or sell any particular
security or fund. The information and opinions contained in this document have been compiled or arrived at based upon information obtained from sources believed to
be reliable and in good faith. All such information and opinions are subject to change without notice. A number of the comments in this document are based on current
expectations and are considered “forward-looking statements”. Actual future results, however, may prove to be different from expectations. The opinions expressed are
a reflection of UBS Global Asset Management’s best judgment at the time this document is compiled and any obligation to update or alter forward-looking statements as
a result of new information, future events, or otherwise is disclaimed. Furthermore, these views are not intended to predict or guarantee the future performance of any
individual security, asset class, markets generally, nor are they intended to predict the future performance of any UBS Global Asset Management account, portfolio or fund.
© UBS 2015. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.
24241