The remarkable thing about this is instead of dumping UK bonds and currency the market has driven 10-year gilt yields below 1 per cent for the first time in recorded history and the Sterling has resolutely rejected the 1.3000 level against the US dollar before recovering quite well, under the circumstances. It is certainly acknowledged part of GBP/USD fall could have had a ratings risk adjustment included in.
The question therefore might reasonably be asked: what relevance do sovereign ratings really have to market prices in the current era, given demand continues to exceed sovereign bond supply in many markets, regardless of the rating the bonds carry?
This is obviously relevant for the UK at the current time, but it is also particularly relevant for countries such as Australia where the Reserve Bank and the market have indicated additional fiscal support is preferable to more monetary policy stimulus.
That preference has generally been rejected in Canberra on the basis additional debt issuance might place Australia’s hard-won AAA rating in danger. The same question might reasonably now be posed downunder: “So what if Australia loses its AAA rating? If the market keeps buying the bonds anyway, what is the point of worrying about what the ratings agencies say?”
Such arguments obviously oversimplify the issue. They ignore concerns about maturities and new issuance, and they ignore the potential problems that may be faced by the Australian State government issuers, and the impact on non-government corporate credits. Each of these will be affected differently by the loss of the AAA rating.
Despite that, defence of the AAA rating as a powerful argument against fiscal expansion is no longer as potent as it once was. The post-crisis market has certainly paid less heed to ratings than it did before and end investors are less accepting of the rating as the only determinant of risk.
The other important change is the global squeeze on fixed income assets, and most especially on government bonds, has meant supply, coupon and availability all now rank above the rating in the minds of many buyers of government bonds.
Another good example of the squeeze-in is being seen in government bonds globally is the relentless rally taking place in New Zealand. New Zealand’s generic ten-year government bond yield has fallen approximately 125 basis points this calendar year, and by 62 basis points this quarter.
The current implied rate at the close today was just above 2.30 per cent. That yield is just 30 basis points above the middle of the RBNZ’s inflation target band, which it is mandated to reach over the medium term.
Assuming investors have faith in the RBNZ’s ability to achieve its mandate over the future period the current bond yield is thus guaranteeing a real return very close to zero.