Dec 19 - Declining yields for U.S. corporate bonds have
created the potential for a 'bond bubble' under which a rising interest rate
scenario could result in significant valuation losses for institutional
fixed-income investors, according to a Fitch Ratings study.
The persistence of abnormally low interest rates - and the inevitable reversion
to higher levels - is an issue with many dimensions, affecting financial
markets, credit conditions, and economic growth. Fitch's study focuses on
identifying, sizing, and contextualizing the risks of rising rates to
To provide context to the interest-rate-risk portion of the 'bond bubble,' Fitch
analyzes the potential losses on a hypothetic yet representative 'BBB'-rated
U.S. corporate bond under a various scenarios. Under one Fitch scenario, a
typical investment grade U.S. corporate bond (i.e. 'BBB,' 10-year maturity)
could lose 15% of its market value if interest rates were to rise to early-2011
levels (a 200 basis point rise). Under the same scenario, a longer duration
bond (e.g. 30 years) could experience a 25% valuation loss.
By comparison, these potential market-related losses would far exceed the
roughly 50bps in credit losses on Fitch-rated 'BBB' corporate bonds experienced
in 2002, the highest historical default rate for this set.
While the $8.6 trillion U.S. corporate bond market could experience significant
market value losses, the risks to longer-term, income-oriented investors (e.g.
insurance companies) are mitigated by asset-liability management (ALM) and other
Trading-oriented investors and outliers that deviate from sector norms (e.g.
longer duration portfolios) face elevated risks in a rising rate environment.
Fitch's analysis looked at the effects across all types of major institutional
The timing, pace, and magnitude of future rate increases is critical to how
these risks play out. Monetary policy will likely remain accommodative for the
next several years, reducing the near-term likelihood of a rate increase.
However, a continuation of low rates could exacerbate the ultimate risks to
investors, since over time a larger share of portfolios would consist of
The full report 'The Bond Bubble: Risks and Mitigants' is available at