Sovereign Risk Is Highlighted By Rising Yields, But The Bond Outlook Is Boosted

There has been a surge in government bond yields over the past year, which is boosting the allure of debt for investors, even as it heightens the risk that governments may be unable to service their debts because of the soaring costs of servicing borrowings.

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The Australian Financial Review Business Summit in Sydney held on Wednesday was a great opportunity for investors to share their insights. The yield on two-year Treasury bonds jumped to 5.08% at the end of last week, the highest level since 2007 as Federal Reserve Chair Jerome Powell signaled the central bank is ready to quicken the pace of tightening at any time. 

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"With yields having returned to their long-term norms, bonds have the ability to perform well in the current environment," said Amy Xie Patrick, head of income strategies at Pendal Group Ltd. Since bonds suffered such huge losses last year, many investors have shunned fixed income as an asset class. However, I would argue that 2022 is probably much more of an anomaly than a typical year.

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There has been a loss in bonds globally for investors over the past two weeks as January's gains have been erased as investors bet that rates will rise higher than previously expected, causing bond prices to fall. Investors in fixed-income securities have suddenly changed their minds, as recently as the end of last month, they were banking on an end to the growth in interest rates. 

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Tim Sims, managing director of Pacific Equity Partners, believes that the persistent rise in yields does raise concerns relating to the asset market more broadly, especially when it comes to the potential need to reassess sovereign risk as well.

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'We've got countries running huge deficits at huge multiples of their GDP and at a massive scale,' Sims said in a statement. The chief concern, according to him, is the fact that many countries, such as France and the United States, have virtually unfunded liabilities because of the commitments that they have made under pension funds and other strategies. 

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When interest rates rise, countries will have a hard time paying, Sims said, which will impact their sovereign risk assessment and the bond market.

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There is also a possibility that higher yields can sap private equity investors' returns by reducing their potential sale prices when investors are looking to exit their investment by selling the business they bought during the previous period of low-interest rates.