The large arb-unit of the central bank
Western central banks are tightening their belts and ending the era of cheap money, but they are doing so at radically different paces. This will create funding arbitrage opportunities and create strange phenomena in the primary market ready for borrowers to exploit.
Jim Bullard, a hawk on the US Federal Open Market Committee, spoke out this week on the possibility of a 75 basis point rate hike this year as the Bank of England is on track with its rate hike program, having already raised rates three times in this circuit.
The European Central Bank stands out. It is sticking to its sequencing plan, which means it must end net bond purchases before it can raise rates. This is widely believed to mean the end of net buying for its asset purchase program this summer, with the first rate hike coming in September. There is even growing belief that the ECB will put in place another, less formal, bond-purchase facility to keep Eurozone spreads contained in the event of a crisis.
This dislocation in the fight against inflation among central banks will open up a world of funding arbitrage opportunities unprecedented this decade for the bond market, the beginnings of which are already being felt.
The dollar market for SSAs heated up this week in terms of issuance volumes, for reasons bankers struggled to pinpoint, but came as 10-year Treasury yields rebounded from lows. three-year highs. Meanwhile, financial institutions repaying their debt in dollars have found cheaper funding in euros, pounds sterling and Swiss francs than they could get at home.
Next week, bankers expect the Euros to be the market again to pump trades into SSA, while dollar volumes soar.
The market should expect to see more. A statement from a policy maker between meetings, or a shocking piece of data, now has the power to dramatically alter interest rate and yield expectations.
One week the euros will be raging, only to come to naught a few days later because a policy maker made a comment, then suddenly the pound becomes the best place for those who can print data on it to the inflation.
Issuers need to stay as nimble as possible to take advantage of this.