Government bonds face 'tumult' in 2010, Moody's warns
Many of the world’s governments borrowed and spent with abandon this year to keep their economies afloat. And investors mostly were happy to oblige, providing enough demand for sovereign bonds to keep a lid on longer-term interest rates.
But now what? Moody’s Investors Service is out with a preview of the relative risk in government bonds in 2010, in a report titled “Fasten Your Seat Belts: Tumultuous Times Ahead.”
The issue for investors in most government bonds isn’t the risk of outright default, because politicians and central banks can always print more money. The question is whether investors will demand much higher interest rates to continue financing governments that have dug themselves into deep financial holes.
If market yields on new government bonds surge, older fixed-rate bonds issued at lower rates will plunge in value.
Greece may be providing an early warning of how investors will treat bonds of countries whose fiscal houses appear way out of order. The yield on 10-year Greek sovereign bonds has soared from 4.86% in mid-November to 5.73% now amid growing fears about the government’s ballooning deficit.
Greece ranks fifth on a new “misery index” that Moody’s compiled to show the “challenges facing some economies in the coming decade.” A country’s index number is the sum of its budget deficit as a percentage of gross domestic product and its unemployment rate.
One way to look at the index rankings: A country with a high index reading may already be spending aggressively to try to bring down unemployment. What level of interest rates will investors demand to finance further government spending aimed at reducing joblessness?
The U.S., with an index reading of 20.7, ranks in the middle of Moody’s list. Spain is in the worst shape, at 30 on the index.
U.S. long-term bond yields remain below their peaks of earlier this year, but they’ve been rising for the last two weeks, lifting the 10-year Treasury note yield to 3.59% Tuesday from 3.20% on Nov. 30.
Three key points from Moody’s about the outlook for government bonds in general:
--- As the global economic recovery attains a more solid footing, 2010 will at best see a “normalization” and at worst a severe tightening in government financing conditions. Long-term interest rates may increase more rapidly than expected because of an over-reaction to economic news, which we believe will be mildly positive overall. Moreover, the slow unwinding of “quantitative easing” [by central banks] will accelerate this credit repricing process.
--- The end of exceptionally low financing conditions will expose the true cost of the crisis on government debt affordability across the world.--- Aaa-rated governments will probably not have the luxury of waiting for the recovery to be secured before announcing and perhaps also implementing credible fiscal consolidation programs.
-- Tom Petruno