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Europe's Long-Bond Bonanza Goes Bust. Who Will Follow?

Making sense of the 2016 crash in Europe’s long-dated debt markets

by Nico Isaac
Updated: January 06, 2017

Okay, so here’s the thing: There are long bonds. And there are super long bonds, like 40-year, 100-year, 1000-year, even bonds with indefinite maturities that go into perpetuity. They have fun, catchy names like “Centennial” bonds or “Methuselah” bonds.

They’re just rarely used. Like the “2” gear on an automatic transmission. It’s there on the off chance you’ll need it; but 99% of the time, you’re perfectly fine using “D.”

Until 2016 that is, when a flurry of eurozone countries kicked their debt markets into the highest-possible gear amidst what one Financial Times article coined a “long-bond bonanza.” Between March and July 2016, these countries issued multi-decade bonds to record-shattering demand:

Ireland (100-year bonds), Belgium (100-year bonds), France and Belgium (50-year bonds), Switzerland (42-year bonds), the UK (50-year bonds).

To illustrate the dramatic shift toward the long-end of the bond curve, the Financial Times piece provided this stunning visual and wrote:

“Around one-half of Europe’s corporate bond sales have a maturity of 10 years or more, as of May 2016, up from 5% at the start of the year.”

Added one Reuters: “More than one-quarter of bonds issued in the first four months of the year will expire in 12 years or more, the highest share of overall issuance since the eurozone was established in 1999.”

Which brings us to the why?

Well, the general consensus was desperation; i.e. in the “new normal” of negative yields, long-dated debt at least provided some return. Peanuts were better than the empty shells of peanuts. And the clock was ticking: Yields on the Spanish 30-year bond was 7.6% in 2012 versus 2.8% in May 2016.

Wrote one May 21 Telegraph:

“Where there’s no opportunity for growth, investors will seek out the lowest risk alternatives for their money. Government bonds, where risk of default is low to non-existent, are the home of choice.”

In our opinion, the notion of “non-existent” risk is, in of itself, non-existent. There’ no such thing. We explained as much, over two years ago. There, in the October 2014 European Financial Forecast, we warned how extreme optimism can blind investors to potential risks in the desperate pursuit of return:

“An optimistic mood extreme pushes bond investors to make one of two critical errors: They purchase debt securities issued by weaker borrowers, exposing themselves to nonpayment. Or they purchase longer-term debt, exposing themselves to rising interest rates. Both tactics try to maximize returns in a low–interest rate environment, and both strategies prove fatal when social mood turns negative.”

Flash ahead to the 2016 “long-bond bonanza” and our July 2016 European Financial Forecast re-emphasized the likelihood of losses in the great yield chase:

“Today’s bond market is even more dangerous [than 2008] by most measures. Since 2008, for example, the average duration of all the bonds in the S&P Pan-Europe Developed Sovereign Bond Index has jumped more than 60%.

“Duration is a critical gauge of bond-market risk, because it approximates how many years it will take for an investor to be repaid their purchase price. In other words, greater duration translates into greater losses if interest rates start rising.

The effective duration of European government bonds surged to a two-decade high of 7.5 in May 2016. Which means: bond investors kept buying debt despite needing nearly eight years to recoup their investment. That’s complacency with a capital lun-a-“C.”

The July European Financial Forecast took a bearish stand:

“According to one columnist, ‘There’s no mystery about the advantages of long-term financing at this point: Demand for Treasuries + ultralow rates + big and persistent U.S. funding needs = 50-year bond.’

“It’s an elegant formula, we have to admit. In the years ahead, the equation will bankrupt more nations and more investors than we care to contemplate.”

Now, the January 2017 European Financial Forecast revisits the scene to find the long-bond bonanza busted, with no eurozone economy exempt from the record of casualties:

  • Belgian and Irish century bonds plunged nearly 30% since their all-time highs
  • Prices on 70-year Austrian debt is off 17%, peak to trough
  • 50-year bonds in France, Spain and Italy have likewise joined the global sell-off, ‘leaving investors who bought the bonds facing large losses.’ (Financial Times 12/12/16)
  • Italy’s 50-year bond: Peak to trough, prices fell to 84 on November 23, a 14% loss in just four weeks

 

Despite the global debt collapse, faith in the long-bond game continues. In December 2016, U.S. President elect Donald J. Trump’s nominee for Treasury secretary suggested he would consider the issuance of 50- or 100-year bonds. While one December 9 CNBC wrote:

“I want the U.S. Treasury to issue 100-year bonds as soon as possible to take advantage of generations interest rate lows that we will not see again for hundreds of years.”

In our opinion, how the long-bond story unfolds is guaranteed to become something future generations will remember for 50- and 100-years to come. 

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