NEW YORK--(BUSINESS WIRE)--This year's dramatic fall in yields on bonds issued by investment grade sovereigns has again raised the risk that a sudden interest rate rise could impose large market losses on fixed-income investors around the world, Fitch Ratings says. A hypothetical rapid reversion of rates to 2011 levels for $37.7 trillion worth of investment-grade sovereign bonds could drive market losses of as much as $3.8 trillion, according to our analysis.
Unconventional monetary policies in Japan, Europe and the US, together with a surge in investor demand for safe assets, pushed sovereign yields to new lows in 2016, with $11.5 trillion in sovereign securities trading at a negative yield as of July 15. This figure fell slightly from the June 27 total of $11.7 trillion as a result of changes in dollar-yen exchange rates and a slight uptick in yields for long-term Japanese government securities.
Global bond investors have seen significant gains this year, particularly on longer-term fixed-rate securities where prices are most sensitive to changes in interest rates.
As rates hit record lows, investors face growing interest rate risk. A hypothetical rapid rate rise scenario sheds light on the potential market risk faced by investors with high-quality sovereign bonds in their portfolios.
Global composite yield curves, derived by Fitch from median yields of the 34 IG-rated countries (with at least $50 billion of outstanding debt) in July 2016 and July 2011, fell across all maturities over the past five years. Median yields on 10-year securities are 270 basis points lower than they were in July 2011. At the shorter end of the curve, median yields on 1-year securities have fallen by 176 bps.
Using July 2011 yields for similar securities to re-price current sovereign debt, we calculated $3.8 trillion in aggregate market value losses across over 2,500 securities currently outstanding.
Potential market losses would be greatest for holders of European sovereign bonds. Sovereign yields for European countries, particularly Italy and Spain, declined significantly since summer 2011 as Eurozone credit risk remained high during that period. If yields in these countries returned to July 2011 levels, the market loss on their debt would be 21% each.
Additionally, the UK's relatively longer maturity stock of debt outstanding would drive total market losses of 19%. For debt with 25 or more remaining years to maturity, investors in European countries would lose 44% in market value on average in this scenario.
The pace of any potential global rate shock would be important. A more gradual rate rise, perhaps driven by a slow tightening of monetary conditions worldwide, would result in far less significant market losses for investors.
The exposure of any particular investor to this type of severe market risk depends greatly on that investor's strategic objectives, duration and fixed-rate risk profiles, as well as reliance on leverage. For many institutional investors such as insurance companies and pension funds, a hold-to-maturity strategy mitigates market risk. Moreover, financial institutions' operating profiles could benefit from a rise in long-term rates, especially if such a change occurred gradually.
This study analyzed the debt issues from the 34 Fitch-rated investment-grade sovereigns with at least $50 billion in debt outstanding, according to Fitch calculations on July 15. The population was comprised of all fixed-rate, publicly held debt listed in the countries' local currencies with yield data available from Bloomberg. The study did not include international bond issues, strips, sinkable, callable, or retail-only bonds.
Loss figures were calculated by mapping yields from 2011 bonds with currently outstanding securities with analogous remaining years to maturity from each country and calculating a new present value bond price, assuming an immediate rise in bond yields. Source: Fitch, Bloomberg.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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