NEW YORK & CHICAGO--(BUSINESS WIRE)--Steep declines in global sovereign bond yields over the past few years have drastically reduced investors' ability to generate interest income from new securities purchases, says Fitch Ratings. Relative to yields available in 2011, global investors are foregoing over $500 billion in annual income on $38 trillion in currently outstanding bonds as a result of the collapse in sovereign yields.
Cash flow benefits have effectively been transferred from global investors to sovereign issuers, as sovereign borrowing costs have dropped in response to central bank monetary stimulus. This has posed new challenges for income-reliant investors, such as insurers and pension funds, while enabling governments to borrow at increasingly attractive rates.
Damage done to investor returns is made clear by the country-level data. Yields for the top sovereign issuers have all fallen substantially since July 2011. The largest declines in weighted-average sovereign yields among the top issuers over the past five years have been seen in Spain (down 422 bps) and Italy (down 413 bps). Both countries faced elevated spreads during 2011, when investor concerns surrounding Eurozone risk were peaking.
The median 10-year yield for the countries in Fitch's study dropped to 1.17% today from 3.87% in July 2011.
Some investors will feel an impact sooner than others. Given the significant downward moves in interest rates over the past five years, many investors have already seen large gains in their bond portfolios. In addition, central banks' holdings of sovereign securities have grown sharply, mitigating the prospective impact of ultra-low rates on private investors.
Still, for many "buy and hold" income-oriented investors, the roll-off of maturing securities requires that new cash be invested at much lower coupon rates. Should rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds.
Issuers will realize benefits slowly as older high coupon bonds mature and new low or negative yielding bonds are issued.
Central bank purchases of debt have contributed to the worldwide shortage of high-quality safe assets. The resulting supply shortages have made it easier for governments to borrow cheaply. Over time, this has the potential to lead more governments to pivot to fiscal stimulus as a tool to boost economic growth. Persistence of ultra-low sovereign borrowing costs could eventually lead to higher government debt levels and increasing leverage, particularly if global growth remains sluggish and doubts over the efficacy of monetary stimulus grow.
Bond investors' global search for yield is leading them to look elsewhere for income, pushing down yields for issuers such as emerging market sovereigns and high-yield corporates with weaker credit profiles. Some income-dependent institutions such as insurers and pension asset managers are likely to face increasing credit risk as yields on high-grade bonds diminish.
Methodology:
The calculation of aggregate lost investor income is based on Fitch's analysis of $38 trillion in outstanding bonds issued by 34 large investment-grade sovereigns. The change in yield to maturity represents the pro forma loss facing investors in 2016, using yields that were available in 2011 on currently outstanding bonds. Source: Fitch Ratings/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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