The 'marginal buyers' in credit are neither marginal nor buyers

The world's “marginal buyers” of bonds are retreating, according to Citigroup strategist Matt King. This matters because their presence has been providing support (direct or indirect) to riskier markets such as equities, credit and real estate.

King's name for the group is not exactly descriptive, however. While these entities have provided plenty of credit, they are not always direct buyers -- and they are certainly not peripheral.

The institutions in question are major global central banks and the Middle Kingdom itself, all of which have plans to slow the pace of their monetary stimulus this year. And it is no coincidence that markets have gotten more wobbly as they have slowed credit creation in their respective economies, he argues:

On the central bank side, the story is clear. After years of easing, central banks' stimulus is now reversing. The Federal Reserve is raising rates and reducing the size its balance sheet (by $30bn of securities a month now) as the ECB tapers its bond purchases, and the BOJ considers a “ slow retreat” from markets:

Even Japanese investors are staging a retreat from US markets -- mildly positive yields on long-term domestic government debt makes a difference, it seems:

And China appears to be reducing the pace of its credit growth. Its success in that endeavour is not yet guaranteed -- Michael Pettis has good thoughts on this -- because credit may be expanding outside of the markets measured by the country's Total Social Financing metric, or TSF. (Also, hat tip to Brad Setser for talking it through with us.)

But TSF growth does appear to be slowing somewhat, as King points out:

As a side note, the US's private-sector credit creation has been much larger than it seems in the chart above, which only includes bank credit and therefore excludes the pre-crisis mortgage securitisations and the post-crisis bond boom. (There was $1.6tn of US investment-grade and high-yield bond issuance last year, and that excludes credit created through bank-loan syndication and securitisations.)

A better comparison of global credit creation can be found in his chart below, which uses data from the BIS to show household and non-financial credit creation as a percentage of GDP:

The relationship between Chinese credit growth and global market prices is not entirely straightforward, however, as it is not clear how mobile that country's capital is.

While 2015's market volatility was a sign that China's financial markets have grown large enough to exert a gravitational pull on the rest of the world, we cannot say confidently that the Middle Kingdom's buyers are themselves piling into offshore markets -- at least the transparent ones. King's analysis of the relationship between China's credit and global real-estate costs is interesting, however:

More in the usual place. His presentation also includes a rebuke to the cast of folks who have warned about the dire consequences of the US's fiscal plans. Unlike business credit, it turns out that US government debt can find buyers pretty easily, even with a large change in supply -- note that the chart below assumes that Treasury supply will maintain its first-quarter pace through the whole year, which is not guaranteed:

Quelle surprise!

To be generous, a more thoughtful fiscal hawk could describe this as a “crowding-out effect”. But in the US markets, CCC-rated bond spreads have narrowed significantly this year. And a growing share of BBB-rated companies are borrowing at investment-grade ratings (and spreads) to finance deals that leave them highly indebted. So it is difficult to see who is getting crowded out just yet.

Fund managers may be the main ones losing out as central banks retreat, amid the brief bursts of market volatility and losses in investment-grade bonds. King says we can expect non-sovereign markets “to remain soft until the taps are turned back on.”

Here's to QE4, then?

Related links:
Elsewhere in unusual interest-rate moves... - FT Alphaville
Ask a bond vigilante: Is the US budget really going to cause trouble? - FT Alphaville