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ULTRAS—GATHERING SUPPORT?

The most obvious consequence of the increasing tension over US – China trade negotiations and the scaling back of expectations for global economic growth has been that bond yields have fallen, and yield curves have flattened or, “inverted”. In other words, longer term rates have fallen below those of short-term rates. In the US at least, this has previously been a fairly reliable indicator that the economy is vulnerable to a recession. Elsewhere it has been less reliable but nonetheless an important indicator to keep an eye on.


At the same time, the fall in yields, along with the expectations of further monetary easing by the Fed and the possible instigation of QE2 by the ECB has resulted in a large segment of the world’s bond markets trading in negative yield territory. Indeed, at present, some $16 trillion worth of bonds now trade on negative yields, $1 trillion of which are corporate bonds. In the cases of Germany, the Netherlands and Switzerland, government bond yields are negative all the way out to 30 years maturity. In effect these governments are being paid to borrow. Elsewhere, even though long maturity yields are not negative, they are at historically very low levels.


This has led many to argue that governments should take advantage of the opportunity to lock in these record low levels of interest expense by issuing ultra-long bonds. These are bonds with maturities of over thirty years (typically 50-100 years) and advocates say that they could be issued by governments now with the objective of funding much needed infrastructure expenditure at very attractive costs while at the same time boosting economic growth.


The concept is not a completely new one. Countries such as the UK, China and the Philippines issued ultra-long debt in the 1990’s. More recently Austria and Argentina have done so but with very different results. The US Treasury which has only issued bonds up to thirty years maturity has considered this at various times over the past ten years and at the end of August, Treasury Secretary Mnuchin indicated that issuing ultra-long debt was under “very serious consideration”.


The advantages for governments reasonably clear. However, there are some disadvantages to the lender. The recent case of Argentina’s 100-year paper losing around 40% of its value in a short period of time has attracted much attention, demonstrating how sensitive these bonds are to changes in perception, of both interest rates and, especially, default. Though its argued that pension funds and insurance companies are natural buyers of such paper because they have long-term liabilities, locking in at the current levels may mean that their ability to meet their return objectives is severely hampered. The reluctance of these investors can be seen in the recent auction of 30-year zero coupon debt by Germany – less than half the target of EUR2bn was subscribed. Perhaps investors are just “ultra-cautious”?

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