Bond Tab for Biggest Economies: $7.43 Trillion in 2014

To what degree are increases in bond yields affecting the refinancing of sovereign debt around the world?

The world’s biggest economies will need to refinance $7.43 trillion of sovereign debt in 2014 as bond yields begin to climb from record lows, threatening to raise borrowing costs while nations struggle to bring down elevated budget deficits.

The amount of bills, notes, and bonds coming due for the Group of Seven (G-7) nations plus Brazil, Russia, India, and China (BRIC) is little changed from 2013 after dropping from $7.6 trillion in 2012, according to data compiled by Bloomberg. At $3.1 trillion, representing a 6 percent increase, the U.S. faces the largest tab. Russia, Japan, and Germany will see refinancing needs drop, while those of Italy, France, Britain, China, and India increase.

While budget deficits in developed nations have fallen to 4.1 percent of their economies from a peak of 7.8 percent in 2009, they remain about double the average in the decade before the credit crisis began. The cost for governments to borrow may rise further after average yields last year rose the most since 2006, as the global economy shows signs of improving and the Federal Reserve pares its unprecedented bond buying.

“Refinancing needs remain elevated in many developed nations, particularly the U.S.,” Luca Jellinek, the London-based head of European rates strategy at Credit Agricole SA, said in a Dec. 30 telephone interview. “The key here is demand rather than supply. If demand drops as growth picks up, and we expect it will, that could put pressure on borrowing costs.”

Debt as a proportion of the economies of the 34 members of the Organization for Economic Cooperation and Development will rise to 72.6 percent this year from 70.9 percent last year and 39 percent in 2007, according to the group’s forecasts.

 

Deficit Spending

The amount of government debt obligations contained in a benchmark Bank of America Merrill Lynch index has more than doubled to $25.8 trillion since the end of 2007, as countries from the U.S. to Japan financed increased spending to counter the worst economic crisis since the Great Depression.

After interest-rate cuts around the world and the Fed’s bond purchases pushed down average yields on government notes to an all-time low of 1.29 percent in May, borrowing costs have since jumped, according to the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index.

Yields climbed to 1.84 percent by the end of December, making the 0.41 percentage point increase in 2013 the biggest in seven years, the data show. That represents an extra $4.1 billion in annual interest on every $1 trillion borrowed.

Bond buyers are demanding more compensation as the Fed plans to scale back its own monthly debt purchases in January to $75 billion from $85 billion and the U.S.-led recovery prompts investors to seek assets with higher returns, such as equities.

Government debt lost an average 0.36 percent worldwide last year, the first decline since 1999.

Based on 41 economists surveyed by Bloomberg on Dec. 19, the Fed will reduce its buying by $10 billion in each of the next seven meetings before ending its stimulus in December.

The U.S., the world’s largest economy, will expand 2.6 percent this year after 1.7 percent growth in 2013 and accelerate 3 percent in 2015, which would be the fastest in a decade, according to economists surveyed by Bloomberg. With Europe and Japan also forecast to grow, the three economies will all expand for the first time since 2010.

“With the Fed pulling back on bond purchases and growth picking up, bond investors will demand higher yields to justify investment,” Mohit Kumar, a money manager at GLG Partners, a hedge-fund unit of Man Group Plc, said by telephone from London. “We need to price in higher risk premium in an environment where rates and market volatility are likely to increase.”

 

Debtor Nations

Even as faster growth helps increase tax revenue, higher refinancing costs may squeeze governments that are still contending with fiscal deficits. Spending will outstrip revenue in the world’s largest economies by 3.3 percent of their gross domestic product this year, versus an average of 1.75 percent in the 10 years through 2007, data compiled by Bloomberg show.

In the U.S., the world’s largest debtor nation with $11.8 trillion of marketable debt obligations, the amount due this year will increase by about $187 billion, data compiled by Bloomberg show. France, faced with an economy that has barely grown in two years, will see the amount of debt securities due this year rise by 15 percent to $410 billion.

China will lead emerging-market economies with the amount of maturing bonds increasing by 12 percent to $143 billion.

Japan will have $2.38 trillion of bonds and bills to refinance this year, 9 percent less than in 2013, while the amount of German debt maturing this year will decrease by about 5.3 percent to $268 billion.

Including interest payments, the amount of debt that needs to be refinanced by the G-7 countries plus the BRIC nations this year increases by about $712 billion to $8.1 trillion, according to data compiled by Bloomberg.

“There has been a shift of a significant amount of debt” into the public sector during the crisis, said Nicholas Gartside, London-based international chief investment officer for fixed-income at J.P. Morgan Asset Management, which oversees $1.5 trillion. “Despite some improvement on the debt front, there is still a lot of deleveraging to go. The process is still ongoing and will continue for many years.”

 

Consumer Prices

Forecasters are overestimating the likelihood government debt costs will increase because the global economic recovery remains fragile and disinflation is starting to emerge, according to Steven Major, head of global fixed-income research at HSBC Holdings Plc, Europe’s largest bank.

The world economy will to expand 2.83 percent this year, according to forecasts compiled by Bloomberg, slower than the average 3.43 percent during the five-year span between the end of the dot-com bust in 2002 and the start of the credit crisis.

Slowing inflation also preserves the purchasing power of fixed-rate interest payments, which may support demand for bonds. Consumer prices in the U.S. will rise less than 2 percent in 2014 for a second straight year, which has only happened one other time in the last half century, data compiled by Bloomberg and the Bureau of Labor Statistics show.

In the 18 nations that share the euro, the inflation rate will be 1.2 percent, the lowest in five years.

“Growth may have picked up, but it’s still pretty weak compared to previous cycles,” Major said in a telephone interview on Dec. 31. “Inflation is falling in many developed countries. Central banks should be worried about disinflation rather than inflation. It’s hard for me to imagine that bond yields will rise much against this backdrop.”

Some nations are starting to rein in spending, which may help contain borrowing costs. Government bond sales in the euro area, excluding issuance used to refinance maturing debt, will decline to 215 billion euros ($293 billion), the least since 2009, Morgan Stanley predicted.

Germany said in December that it plans to curb bond and bill sales this year by 17 percent to 205 billion euros as tax revenue rises and Chancellor Angela Merkel seeks to end net new borrowing by 2015. In the U.S., the budget deficit will drop to to 3.4 percent of the economy this year, versus 10 percent five years ago, economist forecasts compiled by Bloomberg show.

Demand at U.S. government debt auctions remained stronger than before the financial crisis, as investors bid for 2.87 times the amount sold last year, the fourth-highest ratio on record and surpassed only in the the prior three years.

Buying of Japanese debt was underpinned by the Bank of Japan’s commitment to buy 7 trillion yen ($71 billion) a month of bonds, a pace that would equal more than 50 percent of the 155 trillion yen in notes that Japan plans to sell this year.

 

Yield Forecasts

“Investors should not and will not be concerned about the supply picture,” said Major, who predicts that yields on the benchmark U.S. 10-year note will decrease to 2.1 percent by year-end from 2.99 percent last week.

His estimate conflicts with the majority of forecasters in a Bloomberg survey, who say U.S. borrowing costs will increase. They anticipate yields on the 10-year notes, which rose 1.27 percentage points last year to 3.03 percent, the highest since 2011, will climb to 3.38 percent on average. No one in the survey projected yields falling below 2.5 percent. The yield was at 2.98 percent as of 9:56 a.m. London time.

Borrowing costs in all the G-7 nations are poised to increase in 2014, based on the estimates. Yields on German bunds will increase to 2.28 percent by year-end, while those for similar-maturity U.K. gilts will end the year at 3.36 percent. That would be the highest for both nations since 2011.

Among the BRIC nations, only bond yields in India and China are poised to drop, the data show.

With global growth picking up, investors such as Standard Life Investments predict government bonds will underperform this year and are holding a greater proportion of equities than their benchmarks used to measure performance.

“We are not enthusiastic about government bonds,” Frances Hudson, a strategist at Standard Life in Edinburgh, which oversees $294 billion, said in an telephone interview on Jan. 2. “It’s reasonable to expect bond yields to rise from record lows as recovery gains momentum.”

Following is a table of projected bond and bill redemptions and interest payments in dollars for 2014 for the Group of Seven countries, Brazil, China, India and Russia using data compiled by Bloomberg as of Dec. 30.

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