Accumulated losses of dollar bondholders have exceeded $4.1 trillion.
These calculations include all dollar bonds issued within the U.S. financial system by U.S. residents, with the difference between par value and market value on the cut-off date of March 31, 2024, based on proprietary calculations using Z1 data.
Unrealized losses are attributable to all dollar bondholders, including non-residents.
Unrealized Losses and Market Dynamics
By Q4 2020, when bonds became very expensive, the unrealized gain was $2.8 trillion, and the maximum unrealized loss came in Q3 2023 at $5.8 trillion, i.e., a negative revaluation of over $8.6 trillion. This is due to MPC tightening.
Bond prices change for three reasons: changes in bond quality/investment grade due to expectations of issuer deterioration, large-scale reallocation of capital from the bond market to any other market segment, and changes in the MPC (both actual rates and intention forecasts).
Currently, the biggest impact is the Fed's MPC. Losses are affected by bond duration. How are the losses of $4.1 trillion in Q1 2024 distributed?
Over $2 trillion is concentrated in Treasuries (-7.6% for all U.S. government debt), about $1.1 trillion in corporate bonds (-6.9%), MBS and agency paper $0.9 trillion or -7.4%, and municipal bonds lost only $80 billion or -2%.
Impact of Unrealized Losses
The unrealized loss is irrelevant if the investor brings the investment to maturity, and the issuer returns the face value to the bondholder along with the coupons.
The unrealized loss matters if, for some reason, the investor sells the securities, locking in the loss.
What will it lead to?
- First of all, a decrease in market liquidity and trading volume, especially for long-term bonds, with all the consequences that follow.
- A decrease in the available margin of the investment portfolio and a reduction of leverage in the market.
- Reduced demand, especially in the segment of low-quality bonds, which reduces the possibility of debt refinancing.
- Increased credit risk and revision of investment strategies.
Conclusion
The $4.1 trillion accumulated losses among dollar bondholders reflect challenges within the U.S. financial system. Despite previous gains, tightened MPC led to a significant reversal, affecting various bond types. While unrealized losses may seem negligible if bonds are held to maturity, they pose risks if investors sell. Consequently, these developments are anticipated to trigger reduced liquidity, portfolio margins, demand, and heightened credit risks, necessitating a reassessment of investment strategies.