Investment grade bond indices are far riskier today than during the financial crisis and global debt has ballooned to a new record high, according to analysts at Bank of America Merrill Lynch.
Over the past few days, we have been examining the findings of BofA ML’s The Hitchhiker’s Guide to the Investment Universe report, which serves as a primer for investors on the size, composition, risks, returns, flows and valuations of the investment universe.
Having previously looked at overviews of the total market and equities, here we highlight six of the bank’s charts that offer some insight into today’s bond market.
Global debt securities outstanding ($trn)
Source: BofA Merrill Lynch Global Investment Strategy, BIS
BofA ML’s first chart shows how global debt outstanding has reached $100trn – a significant increase from 1990 when it stood at just $13trn and well up from the levels witnessed during the financial crisis.
Debt represents 57 per cent of global financial assets. In previous articles, we showed how total value of global stocks & bonds outstanding has jumped by eight time since 1990 to $175trn today, with equities accounting for $75trn.
The BofA Merrill Lynch ICE global fixed income indices offer a snapshot of which sectors make up the bond universe. Government bonds account for 54 per cent of the total, followed by investment grade corporate bonds, collateralised debt and high yield bonds.
When it comes to government bond issuance, the US Treasury market is by far the largest in the world accounting for $18.4tn of debt securities; this means almost $4 of every $10 of government debt outstanding is a US Treasury. Japan, China, the UK and France are the next four largest government bond markets.
Who owns Treasury securities
Source: BofA Merrill Lynch Global Investment Strategy, Federal Reserve Board, Treasury Department; ‘other domestic’ includes state & local govt, banks & brokers, GSEs; ‘other foreign’ includes Ireland, Brazil, Caribbean, oil exporting countries
The largest owner of US Treasuries are pension and insurance fund, as they hold 17.4 per cent of these bonds, followed by mutual funds & ETFs (12.7 per cent) and the Federal Reserve (12.6 per cent). The world's biggest single country foreign owner of US government debt is China.
BofA ML shows that global debt equalled $244.2trn at the end of 2018’s third quarter, which is equivalent to 318 per cent of world GDP and is a record high.
Central banks have created $11trn of bonds to negative yields
However, the bank’s analysts noted that despite this record debt pile, interest rates are close to record lows a decade after the global financial crisis.
“The reason is the unprecedented intervention in debt markets by central banks,” they explained. “‘Financial suppression’ means there are $11trn of bonds trading with negative yields today.”
The quilt of debt returns since 2000
Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg. *YTD annualised returns as of 19 Mar 2019
In the ‘quilt’ above, we can see where fixed income returns have come from since 2000. In the past 20 years global fixed income has returned 5.3 per cent per annum, while emerging market sovereign debt, high yield and investment grade bonds have massively outperformed cash.
“But interest rates are no longer falling: 30-year US Treasury yields fell from 15.2 per cent in 1981 to 2.1 per cent in 2016; since then they rose to 3.5 per cent in November 2018,” BofA ML added.
“In 2018 investors experienced the worst returns for investment grade and US Treasury bonds since 2008. 2019 marks a return to the trend of ‘down-in-quality’ in fixed income markets, with high yield and emerging markets the best performing bond strategies.”
Sovereign bond market total returns (%)
Source: ICE BofA Merrill Lynch Global Bond Indices
Above, BofA ML shows the yields, duration and returns for major sovereign bond indexes.
This year, the best performing government bonds in 2019 have been Russia (13.2 per cent) and Mexico (9.9 per cent), while the worst have been Japan (-0.2 per cent) and three-month Treasury Bills (0.5 per cent).
The analysts added that global bond market duration hit record high of seven years in the opening quarter of 2018, up from five years in March 2009. This shows that bond investors are now more vulnerable to higher rates.
Corporate bond yields & spreads
Source: ICE BofA Merrill Lynch Global Bond Indices
The yields, risk measures, and credit spreads for major corporate bond indices can be seen in the table above.
Peak-to-trough yields since the global financial crisis have gone from: 7.8 per cent to 2.1 per cent for investment grade (currently 2.9 per cent); 23.1 per cent to 5 per cent for high yield (now 6 per cent); and 10.8 per cent to 3.6 per cent for emerging market debt (now 4.7 per cent).
“Credit spreads rose in 2018 in every sector and region and have fallen in 2019 in every sector except municipals,” BofA ML concluded.
“More than 50 per cent of US investment grade index is now BBB-rated bonds (lowest quality investment grade), a record high and up from 33 per cent in May 2008; i.e. investment grade bond indices far riskier today.”