SOVEREIGN DEBT YIELDS AS INDICATORS OF COUNTRY RISK, ECONOMIC SITUATION AND PROSPECTS.

A Bond is an instrument of debt with a date of maturity and an interest rate known as the yield. Whether issued by governments or corporations, it is an undertaking to return to the holder of the bond, the principal on maturity. In the meantime, the bond is traded like stocks and shares and forex in the market, and the bond’s price/yield fluctuates according to demand and supply. 

While it is true that the yield is determined by many factors it is also true that one of the important factors relates to an investor’s perception of the country’s trustworthiness and/or risk of default. Yields represent what the investor believes is a fair interest rate to pay for holding the bond.  Look at the Table below showing the10-year bond yields of selected countries with yields arranged in descending order and you will see that this is true. 

Notes and clarifications

• Japan’s yield is so low partly because only 13% of Japanese Government 10-year Bond is held by foreigners. There is strong support from domestic buyers for patriotic reasons and because Japan has been in a deflationary situation for decades. Also, for the aging population, fixed income from bonds is still the best choice.

• The Hong Kong Dollar is pegged to the USD yet the fact that its bonds have a lower yield shows that Currency Exchange rate is not the most important factor in determining the yield.

• Turkey has the highest yield because of chronic inflation due to government policies that go against economic realties and fundamentals i.e. like what Trump is doing now.

• Swiss Bond yields are so low not only because of the very low inflation and safe- haven status of Swiss Franc and Swiss banks but also because the government regulations require Swiss financial institutions to hold Swiss Bonds.