Wednesday, March 14, 2012

They Will Come

TMM chuckled to themselves upon reading in the FT that the UK is considering issuing either 100 year or perpetual bonds. Because it was only a couple of months ago that analysts were calling for that famous relic of history, the 3.5% War Loan to be retired. Predictably, this led to the usual spike in its price (see below chart) that has occurred on the multiple occasions that such calls or rumours have surfaced over the past 25yrs.

The War Loan remains one of the shrewdest moves the UK Treasury have ever made, effectively shafting those who bought it in real terms. Which is why TMM think it would be a great idea to issue another one to lock in the very low Gilt yields for the future. Predictably, this has led to a sell-off in Gilts today as markets digest the signaling effect of the news.

The UK wouldn't be the first, with Mexico amongst those to have issued a 100year bond in recent months. And the boasting rights for Chancellor Osborne would be considerable... TMM cringe as they imagine the glee in his budget speech: "This government has secured the credibility and faith of markets. Not only are we able to borrow at the lowest interest rates for decades, we have also been able to borrow for 100years". Or something like that.

TMM have had a chat amongst themselves, and have come to the conclusion that it seems more likely that a new Perpetual bond would be issued than a 100year bond. This is for two reasons: (i) the duration of a 100year par bond paying a 3.9% coupon is 25.6, while that of a perpetual paying the same is about 26.6 - there isn't really any difference between the two, and (ii) this would allow the consolidation of the War Loan into the new Perpetual.

Now, TMM certainly don't want their pension fund managers to touch these turds with a barge pole (and will be writing to them to discourage them). But they suspect that should the DMO announce an issue of either, that real money will lap them them up. Just like those 50year linkers at negative real rates. Staggering. TMM can only assume that the DMO will soon be able to issue Zero-Coupon Perpetual Bonds to this investor fraternity.

TMM think that actuaries and pension consultants will even manage to solve Fermat's Last Theorem of Pension Management and prove that Zero-Coupon Perpetuals are a GOOD thing to own, to the delight of the DMO. But in the cold light of day you really can't get over the fact that 100 years is a very long time in finance. Let's look at 100 years ago. 1912. The British Empire was in full swing, the Boer war was over, what could POSSIBLY go wrong for the holder of a newly issued 100yr bond? Well two World Wars were only the icing on the cake of a century that has seen unimaginable changes, the pace of which has never been known since probably someone rubbed two sticks together and shaved the corners off square wheels. So, no matter how actuarial your spreadsheet do you REALLY want to receive 3.9% for a century of risk?

It, of course, remains to be seen who bears the brunt of the joke. TMM suspect that, ultimately, these particular entities that have been instrumental in keeping long-dated gilt yields (both real and nominal) so low are likely to end up as wards of the state. Case in point, the recent pre-privatization "restructuring" of Royal Mail. So, really, if you were cynically inclined, you could accuse Osborne of blatant book-cooking and Ponzi-scheming. TMM is sure that if there's any fertile ground for HeroZedge-style hysteria, the UK surely must be it. However, luckily the UK still abides by the old "Keep calm and carry on" adage.

All that said, there seems to be a significant amount of evidence that can-kicking plus structural reform is a winning strategy. And while those of Mediterranean origin seem to have a problem with enacting the latter, the UK has a long history of success in this respect. If anyone doubted the commitment to shrinking the UK public sector, this morning's figures showing a 4.5% YoY fall in public sector employment should persuade them.

10 comments:

abee crombie said...

rates are just ridiculous .. how about 3.5% for 8 year corporate. Thats pretty much the best yield pickup you can get without too much duration/credit risk. Wow!

Good luck with pensions meeting their targets with that.

All of the sudden, prepetuals & preferreds dont sound so bad, just like equities.. the CBs are forcing you to play the game

Bob Dobalina said...

Zero-coupon perpetuals are deliverable into CDS contracts, no?

Maybe not completely worthless.

Secret--Sauce said...

Hey, if the the market will buy 100-year paper from Mickey Mouse, who among us dare criticize Chancellor Osborne? As for pension funds, I wouldn't worry: most people would gladly pay tomorrow for benefits received today.

And I'm sure some enterprising IB will strip it, fulfilling your wish of a zero.

Now then, stiff upper lip now, and pyramid up the portfolio with this paper. What's the repo rate? 250 bp of carry over 100 years can't possible lose! You'll be rich I tell ya'

Kermit said...

If you have to ask....

Am I A Goldman Client or a Muppet?

Anonymous said...

on the day that the EBF announces it is to introduce an alternative to Libor, the treasury let it be known that it is considering issuing some paper that will fix off libors for the next 100 years...

Anonymous said...

Where did you get that 3.9% from?

Leftback said...

A dramatization of today's market action, featuring LB as the small kid on the trike....

Mr Whippy

Amplitudeinthehouse said...

They can dress this market anyway they want...it stays YENNISH!

Anonymous said...

C says'
US treasuries managed to get somewhere nicely technical in just 2 days and the CRB is also now at a nice inflection point. I think that USD correlation will kick back in and the moneyflow from treasuries will at least pause.
All in all I'd say Mr Whippy is calling for playtime.

CV said...

Indeed C, as I said in the earlier post this week (and just to show how smart I am ... erm, ok ...)

" was that a break up in US govvy yields I just saw there. TMV, TBT anyone. Could be a juicy move. Yields have a lot of catching up to do and unless the Fed wants to invert the yield curve through Twist and Shout the curve itself may shift up?

Am I being mad?"

Claus