Austrian Treasury head Markus Stix must have been feeling rather tense last week, after daring to conduct a major experiment. For the first time, Austria’s debt management office sold a large federal bond that will not mature for 70 years.
Stress proved to be entirely unwarranted though, as the €2 billion ($2.22 billion) bond was heavily oversubscribed, with buy orders totaling €7.8 billion. This was despite the fact that the annual yield was only 1.5 percent.
“Ultra long-term bonds are on trend, and Austria has crowned it,” said Michael Leister, an interest rate strategist at German bank Commerzbank. This year the proportion of bonds with a maturity of 20 years or more has risen sharply, with 50-year bonds being issued in Belgium, France, Spain and Italy. However, no other euro zone country had issued a publicly-placed bond with a term longer than that until now. The only bonds with even longer maturities had been small 100-year bonds from Belgium and Ireland, placed with just a few private investors.
“Investors have two options in this environment if they still want to achieve positive returns. They can buy securities with a worse credit rating or with a longer term.”
German Finance Minister Wolfgang Schäuble is unlikely to follow the trend. Germany has made it clear that it does not plan to issue any 50-year bonds. “Our long-term financing requirements are covered by the 30-year segment,” the finance ministry in Berlin responded when asked. Nevertheless, Germany has issued €9 billion ($10 billion) worth of 30-year nominal interest-bearing bonds this year, an increase of one third compared with last year.
When asked about Austria’s reasons for apparently having more confidence than Germany, Mr. Stix pointed out that Austria will issue only around €20 billion to €22 billion worth of bonds this year, while Germany’s refinancing requirements come to about €200 billion. “We are only a niche issuer in the euro zone. That means we can also respond more specifically to investors’ requests.” He said that insurance companies and pension funds had very long payment commitments and were therefore interested in long-term bonds.
This recent surge in the popularity of long maturities has occurred because the bond world has been turned upside down, with investors desperately seeking long-term bonds that will give them at least some return. According to the Bloomberg Barclays Index, bonds with a value of $9.8 trillion worldwide were showing negative yields in October. That represents over 20 percent of bonds listed on the index. Negative yields mean that investors buying the securities get back less money at the end of the term than they invested, including in interest payments.
This affects sovereign bonds in particular, a market that Anthony Doyle, a strategist at asset manager M&G Investments, described as “a freak show.” Jim Cielinski, head of bond business at Columbia Threadneedle Investments, echoed this, saying: “Valuations have reached extreme levels, yet investors just keep on buying as before.” Mr. Doyle found it particularly alarming that central banks are still continuing their ultra-lax monetary policies eight years after the financial crisis. The Bank of Japan and the European Central Bank (ECB) have pushed down bond yields to historically low levels by charging negative interest rates on overnight deposits by banks and continuing to buy up bonds worth billions every month.
“Investors have two options in this environment if they still want to achieve positive returns,” said Mr. Leister at Commerzbank. “They can buy securities with a worse credit rating or with a longer term.” Insurers and pension funds in particular, which in Germany hold 80 percent of their investments in bonds, are looking for bonds with long maturities. However, the interest coupons on government bonds are usually below the guaranteed interest rate of 1.25 percent that German life insurers still have to offer. The Austrian 70-year bond bears 1.5 percent interest. One third of the bond went to insurers and pension funds, with funds buying almost the same amount. They are looking for bonds that yield higher interest than the fees they charge their customers to act as asset managers.
Overall demand for long-term bonds with terms of 10 years or above has grown dramatically. According to calculations by Bank of America Merrill Lynch and Bloomberg, investors have purchased a record volume of over $730 billion worth of government bonds with a maturity of “10 plus” this year.
This had paid off for investors until now. Long-term government bonds from industrialized countries have given investors a total return from interest and price gains of more than 11 percent this year, according to Bank of America Merrill Lynch. This gave bonds a clear advantage over the stock market, with the MSCI World stock index having risen only around 0.5 percent since January. However, there is a significant risk that this could reverse. A combination of rising inflation rates, improved economic data and discussions about central banks’ policy has caused bond yields to rise. The yield on 10-year German government bonds, for example, has risen from 0 to 0.17 percent in the last two weeks. “The recent sell-out, particularly at the long end, is only the beginning,” said Bryan Whalen, a fund manager at U.S. asset manager TWC Group.
The problem is that an increase in the maturity or the capital commitment period also entails increased risk. As an example, a rise of one percentage point in the yield would be associated with a 1.8 percent drop in the price of a two-year German government bond, while for a 10-year German government bond it would be 9.5 percent. For the 70-year Austrian bond, an increase of one percentage point in the yield would actually mean a drop of one third in the price.
The Austrian Treasury’s Mr. Stix is unperturbed. “Institutional investors like pension funds, insurers and banks have sophisticated risk management systems. I would therefore expect them to be able to estimate the risks.”
Jan Hildebrand is deputy lead of Handelsblatt’s politics coverage. Andrea Cünnen works at Handelsblatt’s finance desk in Frankfurt, reporting on the bond markets. To contact the authors: firstname.lastname@example.org, email@example.com