One year ago, just as the Fed had started quantitative tightening, i.e., the shrinkage of its balance sheet, JPMorgan’s Nikolaos Panigirtzoglou, author of the populist Flows and Liquidity newsletter predicted that the more than $1 trillion decline in G4 central bank bond purchases in 2018 relative to 2017 would be a key driver for the change in the overall supply/demand balance for government bonds, and result in broadly higher yields across the board. And sure enough, with the 10Y rising from 2.33% one year ago to a multi-year high of 3.24% earlier this month, as government bonds around the globe also saw a material pickup in yields, that prediction has been proven accurate.

Where JPM was wrong was in its estimates for matched pickup in non-central bank demand for government paper, where as Panigirtzoglou admits, he was overly optimistic (more on that shortly). 

So with traders – across all asset classes, including equity, credit and rates, all focusing on what happens to US Treasury yields next, the JPMorgan strategist revisits his previous analysis on global bond demand and supply, incorporating updated supply forecasts both for the balance of 2018 as well as for 2019.

“Given this year has seen the largest increase in excess supply of bonds since 2010, which as we noted last week has together with continued Fed hikes contributed to a tightening in financial conditions that has been reverberating across markets, there has been considerable interest in how next year is shaping up.”

Attention on 2019 is especially acute as the Fed’s balance sheet normalization process is set to accelerate given that it is only in 4Q18 that the monthly cap for the quantity of maturing bonds that are allowed to roll off has reached its steady state of $50 billion/month, which unlike 2018 when QT was just starting, will induce a further increase in net supply that needs to be absorbed by the market of more than $100 billion.

It’s not just the Fed: with the ECB set to end its QE purchases in December this year and we see the BoJ continuing its gradual slowdown in bond purchases to ¥30 trillion in 2019 compared to around ¥40 trillion this year, JPMorgan notes that this collective shrinkage of the G-4 balance sheet means that the market needs to absorb a further decrease in price-insensitive QE demand of more than $400 billion next year.

Here’s the bad news: adding together both the supply and demand side impact, the G4 central bank flow looks set to decline a further $550 billion next year.

Which begs the question: will there be an incremental increase in demand to offset this dramatic net increase in supply in the coming year? JPMorgan’s  answer is hardly what bond bulls are looking for.

To answer the key question for interest rates in 2019, here is what JPMorgan sees in terms of potential offsetting sources of demand to this continued change in central bank flow, which has clearly put upward pressure on bond yields in 2018.