When you and I borrow for a car or a home, the bank we use to finance our purchase charges an interest rate that’s based on our credit history and our credit rating. This rating moves higher or lower based upon standards that speak to our ability to repay the loan.
Sovereign nation debts draw ratings based on a similar model, graded by rating agencies like S&P, Moody’s and Fitch.
Each of these agencies determine the health of a nation’s economy based on growth rates, exports, inflation, etc., as well as its level of outstanding debt, its ability to repay that debt, and its default history.
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After considering all this, the agency will issue a rating from investment grade, AAA, to Baa3, or BBB- to in default (D).
But these rating agencies are neither timely nor very helpful to investors gauging their investment risk.
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See, those rated pay for their rating, a system criticized since rating agencies gave top scores to mortgage-backed securities that lost heavily during the 2008 financial crisis, so it begins with a conflict of interest.
But, it’s interesting that so far in 2016, according to the Financial Times, there have been a record of downgrades to sovereign debt.
Some nations count on revenue from state-owned enterprises, like oil or other commodities, along with taxes. The fall of oil prices led to Russia’s debt default in 1998.
Fitch has downgraded the credit ratings on 14 nations, while S&P cut ratings on 16 nations and Moody’s cut ratings on 14 nations. Some downgrades were because of falling oil prices, as in Saudi Arabia, Nigeria and others. But overall, credit quality is weakening.
You would think that the higher a sovereign bond yields, the worse the credit quality. Kind of like consumers that have low credit scores generally pay higher interest rates to borrow. But, that’s not always the case, especially in developed nations.
Take a look at the table below:
Notice the yield on the U.S. 10-year Treasury note and the yields on the 10-year sovereign bonds below it. All of those listed below the U.S. have worse credit ratings than the U.S., but also yield less than the U.S. The table only shows developed nations with investment grade ratings (AAA to Baa3 or BBB-).
While governments are financing deficit spending at historically low rates, investors are still looking for low-risk investments that pay a decent yield.
Trillion, yes, that’s with a ‘T’
There is about $48 trillion in advanced economy sovereign debt and about $13 trillion of that is trading in negative territory.
That means bond buyers must pay nations to buy their debt!
We saw just about $11 trillion in negative-yielding debt prior to the Brexit vote and near zero just a couple of years ago. The more uncertainty in the world economy, the more investors pile into the safety of sovereign bonds and the more yields are pushed even lower.
The worse the credit quality, the higher the yield and the more attractive those yields are to investors.
Do you see a problem here?
Debt crises are nothing new; we’ve seen them due to wars, recessions or falling commodity prices. But today, because of massive central bank interventions or stimulus programs, investors seeking higher yields are going largely unrewarded for the risk.
When the bubble bursts, there will be nowhere to hide
While the constitution ensures the full faith and credit of the United States to tax and spend, and it does virtually guarantee the repayment of U.S. Treasury debt, it doesn’t mean that you won’t lose a ton of money investing in Treasury bonds.
That also applies to investing in sovereign bond debt of the U.S.
Whatever the Fed (or other central banks) does or doesn’t do, doesn’t really matter. And however Treasury bonds or sovereign bonds are rated doesn’t really matter to Treasury Profits Accelerator subscribers, either.
Overreaction to what happens, or may happen, affects prices and yields in long-term Treasury bonds and is one way subscribers profit.
Editor, Treasury Profits Accelerator