Argentina’s 100-year bond cannot defy EM playbook forever
Gauchos: saddle up. Argentina, one of the world’s most notorious serial defaulters, came to market on Monday with a 100-year sovereign bond, and investors snapped it up with all the macho bravado of the legendary horsemen of the pampas.
Really? A dollar-denominated bond that pays back 100 years from now, from a junk-rated country that has barely managed to stay solvent for more than half that time in its entire history as a creditor? While there is certainly an investment case for taking part, several analysts warn that this issue is a classic sign of a market getting ahead of itself.
The point, though, is not the 100 years. The complexities of bond maths mean that, once maturities go beyond 30 years, the investment case barely changes. Barring default, with a yield of nearly 8 per cent, the bond will repay investors in full in about 12 years, all else (such as inflation) being equal — and that’s leaving aside its resale value. Many investors will have much shorter horizons.
In a world starved of yield, the 7.91 per cent on offer proved to be quite a pull and the bond attracted orders of $9.75bn for the $2.75bn issued. “People are looking out over the next 12 to 24 months and see a pretty positive outlook [for Argentina],” says David Robbins, head of emerging markets at TCW in New York. “Duration in high yield is something they are more comfortable with.” Argentina, he notes, is in effect selling equity in its economic recovery.
With so much else priced to perfection on global markets, this may seem to go with the territory. But others warn that we have been here before.
Sérgio Trigo Paz, head of emerging market fixed income portfolio management at BlackRock, says the rationale and the pricing are all good. But, he adds: “When you put it into perspective, it gives you a sense of déjà vu.”
While there is certainly an investment case for taking part, several analysts warn that this issue is a classic sign of a market getting ahead of itself Argentina’s is not the only noteworthy sale this week. Russia reportedly attracted demand of more than $6bn for 10-year and 30-year eurobonds expected to be priced later on
Tuesday at yields of about 4.25 per cent and 5.25 per cent respectively. This is happening just as the US Federal Reserve has embarked on “quantitative tightening”, raising interest rates last week for the second time this year and preparing markets for an announcement on how it will begin shrinking its supersized balance sheet later in the year.
It is not hard to see parallels between today and 2013, when the Fed announced the approaching end of quantitative easing just as investors were piling with enthusiasm into a series of high-profile eurobond issues by African governments. Some of those went badly wrong as investors fled emerging markets in the subsequent “taper tantrum”.
Investors may feel Argentina is less vulnerable this year to the dangers of “original sin” — issuing debt in dollars that must be serviced from revenues in your own, potentially weakening currency. Last year’s dollar strength has faded and the peso has weakened against it by only about 1.5 per cent this year.
While a repeat of the taper tantrum is not expected, Mr Trigo Paz is among those warning that we are nevertheless at an inflection point.
He sees two scenarios. In one, the Fed is right about inflation and rates will continue to rise. This would turn the Argentine bond into “a bad experience”. In the other, markets are right, US inflation and payrolls will disappoint and we will be back in a low rate environment, which will be good for the bonds — until deflation rears its head again, hurting the Argentine economy and its ability to pay.
In the meantime, he says, there is a “Goldilocks” middle ground in which investors can suck up an 8 per cent coupon. Beyond that: “It doesn’t look good either way — which is why you get an inflection point.”
Jim Barrineau, co-head of EM debt at Schroders, agrees. “Issuance like this will be the most volatile when the market cracks,” he says. “You do well until you don’t.”
At bottom, the question is whether the strong flows into EM assets this year, more than $35bn into EM bond funds alone, will continue to cushion investors from upsets down the road. It may be that the sheer quantity of money in search of yield will overpower events.
“You’re getting a ton of inflows, including passive inflows, compression of yields and compression of default risk,” says Mr Barrineau. “And people need to put money to work.”
However, he added: “History shows in EM that this type of environment doesn’t last for ever.
“This is the type of thing that when the tide turns is just poised to underperform. We’d rather pass on issues that appear to be the product of a frothy market.”