J.P. Morgan expects bond yields to fall some in 2023 as demand/supply balance improves

J.P. Morgan strategists, headed by Nikalaos Panigirtzoglou, expect a small amount of downward pressure on global aggregate bond yields in 2023, as they calculate an improvement in the demand/supply balance for 2023 is close to $1T, as bond supply declines more than demand.

An improvement of $1T in supply/demand implies downward pressure on Global Agg yields of ~40 basis points, they said.

They estimate global bond demand to contract by ~$0.7T next year vs. 2022 and supply to drop by $1.6T.

G4 central banks’ demand for bonds are expected to decline $1.5T in 2023, on top of the $1.7T deterioration demand seen in 2022, the strategists said.

Retail investors also play a part. “Given [the] sharp rise in global yields in 2022 to levels last seen around or before the financial crisis, the repricing of yields should in our mind provide an incentive for retail investors to increase bond holdings, particularly in an environment where central banks’ policy rates peak in 1Q23 and U.S. growth slows gradually through the year,” the strategists wrote in a recent note.

One of the risks to that scenario is that the Fed policy rates, expected to rise to ~5%, fail to bring inflation down. That would push yields higher and outflows could continue through at least the first half of 2023, they said. A second risk is that inflation remains elevated even as inflation comes down, leading to a more rapid increase in bond demand from retail investors.

“As a baseline, we conservatively project net inflows of around $250B in 2023, in line with the lower end of its range over the past decade, which would represent net improvement in demand of around $0.5T,” the JPMorgan strategists wrote.

For G4 commercial banks, the strategists expect about $200B of net selling of bonds in 2023, representing a net improvement in bond demand by ~$240B relative to 2022.

Looking at G4 pension funds and insurance companies, they project unchanged demand relative to 2022, as the strategists see a “strong incentive for defined benefit pension funds to lock in the gains in the funded status” that occurred this year.

For bond supply, the J.P. Morgan strategists expect net issuance to decline to pre-pandemic levels of ~$2.7T, with broad declines across government and spread product issuance.

Note that the Vanguard Total Bond Market ETF (BND) has been improving in the past month as seen in this chart, though it’s still down 15% from a year ago, just slightly worse than the S&P 500’s 14% decline. The Pimco Active Bond ETF (BOND), by comparison, fell 17%.

SA contributor Modern Income Investor spells out why it thinks the BOND ETF is the wrong strategy at the wrong time.