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Moody's Sovereign Risk Report Summary

Core Content

This report from Moody's Analytics discusses the decline in sovereign default risk as global financial markets react to the U.S. Federal Reserve's decision to hold interest rates steady and the subsequent impact on market-based credit risk measures. It highlights the changes in credit risk metrics for various countries, particularly in the context of global economic conditions and monetary policy decisions.

Main Points

• U.S. Federal Reserve Decision: On January 27, 2016, the Fed kept its benchmark interest rate target unchanged, signaling caution due to a slowing U.S. economy with weaker exports and inventory investment. This decision eased concerns about a potential rate hike, leading to a reduction in sovereign credit risk.

• Emerging Market Credit Risk Decline: Countries with large current account deficits and low currency reserves, such as Turkey, South Africa, and Indonesia, saw notable declines in their Sovereign EDF™ (Expected Default Frequency) metrics. Turkey's EDF dropped from 0.18% to 0.13% over two weeks, while South Africa and Indonesia's EDFs also declined significantly.

• European Credit Risk Trends:

  • Peripheral Countries: Spain, Italy, and Poland showed the most significant one-week decreases in credit risk.
  • Core Countries: Credit risk for core European countries remained largely unchanged.
  • Eurozone Inflation: The Eurozone's inflation rate rose slightly to 0.4% in January, but oil prices and global uncertainties led the ECB to consider policy adjustments.
  • Government Bond Yields: Long-term yields on government debt for Spain and Italy declined, indicating improved investor confidence in ECB policy.
  • France: Showed signs of economic recovery, with its one-year Sovereign EDF remaining stable at 0.01%.

• Japan's Policy Response: The Bank of Japan introduced a negative interest rate policy on January 29, 2016, to address global volatility and uncertainties in emerging and commodity-exporting economies, including China. This move led to a decline in Japan's credit risk and a positive market reaction, with the Nikkei rising and the yen depreciating.

Key Information

• Sovereign EDF Trends:

  • Turkey: 1-Year EDF declined from 0.18% to 0.13%, 5-Year EDF from 0.82% to 0.75%.
  • South Africa: 1-Year EDF dropped from 0.18% to 0.22%, 5-Year EDF from 0.86% to 0.75%.
  • Indonesia: 1-Year EDF declined from 0.12% to 0.11%, 5-Year EDF from 0.92% to 0.75%.
  • Spain: 1-Year EDF decreased by 14% in one week.
  • Italy: 1-Year EDF declined by 7%.
  • Poland: 1-Year EDF decreased by 7%.
  • Japan: 5-Year EDF dropped from 0.12% to 0.09%.

• Monetary Policy Impact:

  • The Fed's decision to hold rates steady reduced market-based sovereign credit risk.
  • The ECB's response to global volatility and economic concerns included reviewing its monetary policy.
  • Japan's negative interest rate policy was a surprise move, reflecting global economic conditions and uncertainty.

• Market Reactions:

  • Positive market responses to the Fed and ECB decisions, with declines in credit risk metrics.
  • Japan's market reacted well to its policy change, with the Nikkei rising by 3.3% and the yen sliding against the dollar.

Summary of Key Changes

Conclusion

The report indicates that sovereign default fears have generally subsided due to the Fed's decision to hold rates and the ECB's potential policy adjustments. Emerging markets and peripheral European countries showed significant improvements in credit risk metrics, suggesting a more stable global financial environment. Japan's response to global volatility also contributed to a decline in credit risk, reflecting broader economic concerns and policy adjustments.