The rush for Argentina’s 100-year bond points to an investment bubble
How do you say “credit impulse” in Spanish? Investors might find it sensible to ask this question now. This week, Argentina startled the markets by issuing $2.75bn worth of century bonds, with an effective yield of 8 per cent. You might have thought this would be a hard thing to sell. After all, Argentina has defaulted on its debts eight times in its 200-year history, with no less than five defaults in the past century alone, most recently in 2014 amid a legal dispute with the Elliott hedge fund.
Indeed, the country is still considered such a big political and economic risk that the MSCI bond index, reviewing country rankings this week, left Argentina ranked as a “frontier” nation, rather than upgrading it (like China) to the emerging market camp.
But investors do not seem to care: there were $9.75bn of bids. And Argentina is not the only peculiar event in bond markets this month. Take a look, for example, at Ivory Coast. In recent weeks, this west African nation underwent yet another military uprising. But this month it sold 16-year bonds with a 6.25 per cent yield — and these were also heavily oversubscribed. Places such as Senegal and Egypt have also seen hot demand for their debt.
So, too, in developed markets. Italy, for example, has a debt-to-gross domestic product ratio of more than 130 per cent, a stagnant economy and a weak government. But its 10-year debt trades below 2 per cent. Meanwhile, Illinois was just downgraded to one notch above junk by S&P — the lowest rate given to an American state. Its bonds have barely moved this month, with 10 years trading at 4.4 per cent.
This is why “credit impulse” matters. If you ask investors why they are gobbling up these bonds, they will usually mutter about a global slowdown in the rate of inflation and country specific factors. The 2117 Argentine bond attracted bids, for example, because its smooth- talking telegenic president, Mauricio Macri, has implemented market-friendly reforms since he took office in 2015.
But the bigger reason why demand is so high is the action of central banks: quantitative easing has pumped so much liquidity into the markets that investors are frantically — desperately — chasing any investment that might produce a return.
If this policy continues, the maths behind these bond purchases could make sense. With a yield of 8 per cent, the 2117 Argentina bond should repay its notional value in 12 years. That makes it a reasonably attractive bet if inflation stays low and the government stable. And if
Argentine rates fall further due to Mr Macri’s reforms — say, towards Brazilian levels or 150 basis points lower — anybody holding the 2117 bond will be able to flip it at a profit.
Indeed, that is precisely what many hedge funds plan to do.
But this scenario depends on a big “if” — namely, that monetary conditions stay ultra-loose.
If you peer into the weeds of the global financial jungle, there are some reasons to question that assumption. Look at those so-called “credit impulse” statistics. Investment banks such as UBS or Citi concoct these indices to measure private credit creation (the degree to which loose central bank policy is prompting global banks to lend money and organise bond sales).
In the past seven years, Citi’s “credit impulse” monitor has been mostly very upbeat: it expanded at a rate of 2 per cent last year, due to $6tn worth of global private credit expansion. This was sharply higher than the $2.5tn credit expansion seen in 2010.
But recently this “credit impulse” series has quietly tipped into negative territory: it sits at minus 0.5 per cent. That is partly because the US Federal Reserve is raising rates. However, another often overlooked factor is that China is tightening sharply, too.
This may be a temporary wobble. The index briefly turned negative in 2014, but rebounded when western central banks loosened policy. If bond markets take fright at the prospect of tightening in coming months, central banks might feel compelled to loosen policy again.
But it is also possible that the credit impulse data point to a watershed. If so, that 2117 Argentina bond may end up being the government bond market equivalent of the Pets.com IPO during the 2001 tech boom — the sign of a bubble peak. Investors should take note, in whatever language they choose.