Eurotower in Frankfurt am Main before sundown

Global bond markets may be challenged by an expected US$2-trillion worth of quantitative tightening by major central banks over the next couple of years, Fitch Ratings says.

In a new report, the rating agency said asset purchase activity by the U.S. Federal Reserve, European Central Bank, Bank of England and Bank of Japan will be negative in both 2023 and 2024.

This follows quantitative easing of US$5 trillion in 2020, US$3 trillion in 2021 and US$500 billion in 2022, representing a “massive swing in the flow of central bank liquidity,” Fitch said.

As a result, global bond markets will have to absorb a growing supply of government bonds “at a time when new government borrowing is still large,” the report said.

This shift from quantitative easing to tightening “could test the resilience of bond market functioning, which was distorted by [quantitative easing],” it suggested, noting that there are signs of reduced depth and liquidity in major fixed-income markets compared with pre-pandemic levels.

“The ‘dash for cash’ episode in March 2020 highlighted the role of selling by mutual funds and leveraged investors,” the report said. It added, “Turnover rates have fallen and primary dealers’ capacity to step up intermediation in times of market pressure has been reduced.”

Last year’s crisis in the U.K. “also revealed risks to smooth bond market functioning from leveraged investors,” Fitch said.