Bond Yields

Brendan,

You won’t hear much either. When yields were at their recent zenith, most doom porn merchants on this blog were extrapolating to infinity and deducing that rising yields were indicative of impending default. It sounded like the scene from Monthy Python with all the prophets outside the temple.

Based on market intelligence it seems the rally was fuelled by distressed debt buyers who judged that there was a high enough probablity of IReland graduating from theIMF remedial class. The reduction in interest rate and ECB buying combined with a slew of neutral economic news also helped. Wilbur’s investment in BOI did no harm either.

It seem there has been very little buying from traditional fund managers.
You now find people forecasting early access to markets. Hold that thought.

I am feeling quietly relieved, but I won’t do any crowing until the price comes back to where I bought the damn things. And I am no less pissed off about Anglo senior bondholders being paid in full while I sweat it out.

Brendan is right that this is an important development that has been a bit overlooked.

There’s little doubt that interest rate cut and the extension of the maturities have had a positive effect on market sentiment on Irish debt sustainability.

It’s also likely that part of the reduction in bond yields since the July 21st deal (particularly at the short end) reflects an assessment that the near-term downside scenarios for bondholders are more likely to involve a smallish haircut along the lines of the IIF-lead deal agreed to by the EU.

The current rates are still too high to be consistent with a return to the bond market any time soon but they definitely are an important sign of progress. Let’s hope this pattern survives the likely re-emergence of Euro turbulence.

@ Karl Whelan

Sorry Karl, I was going to take your point seriously, but Richard Tol has pointed out that you’re the only the 870th best economist in the world. He proved it scientifically you know, so no hard feelings but the cold, hard stats beat any reasoning anytime.

(MayI suggest you make sure you ensure your PhD students give you juicy co-credits in any future (registered!) publications so readers are be able to optimise their opinion of you?)

Turnover, and total stock recently traded are vital accompanients to raw price analysis of any secondary market. Unless volumes are high, I’d tend to ignore short term fluctuations.

@ CP/PR Guy

its not the ECB, they’ve bought some very modest amounts of Irish bonds, and the real buying actually pre-dates the ECB involvement. Look to another continent. It’s a very positive development.

Also, re deficit, i’d expect the government to come out with some aggressive fresh austerity measures next month to take advantage of the positive sentiment. Its also now generally accepted that the ECB is ‘rewarding’ countries for fresh austerity moves.

@ Tull

some distressed buyers. Some very large real money buyers too.

Dollars to doughnuts it’s not the ECB. Ireland has given the 4th best return of Eurozone bond markets ytd, at over 6%. It’s returned over 20% since end-June.

Yields started falling even before the 21st July rate cut/maturity extension agreement ( from admittedly high levels of 23% in 2yr and 14% in 10yr). Turnover as measured by the Stock Exchange jumped to a multiple of the average in H1 2011 of about €200m. Even as Italian and Spanish yields were heading north through 6% in late July, and well before any reactivation of the ECB’s SMP, Irish bonds were in huge demand.

The heights that Irish bond yields reached by mid-July appeared to be due to price-insensitive dumping by some accounts following the Moody’s downgrade. A number of banking/general insurance funds operate investment policies whereby the lowest investment grade ascribed by the 3 main rating agencies is the criterion for investment eligibility. Moody’s downgrade meant some accounts, regardless of their view, could no longer hold Irish debt.

Ireland’s average rating remains investment grade. Unlike Portugal, after it’s downgrade, Ireland remains in the main eurozone and wider bond indices.

Given that, even for active bond funds, probably 80% or so of their investments are effectively indexed or passive, any short position vs indices would, once yields turned, have seen longer-term index measured funds scrambling to cover positions. While Ireland is a modest 1.75% of the 5yr+ indices in the Eurozone, to be index-short of it would have cost funds so positioned a small fortune.

Without daring to predict any continuation or even maintenance of the yield decline, I have to say it’s a bit minnowish for people to assume that every rise in yields is due to national incompetence at an official level, whereas every decline is the product of an ECB fix. The most notable feature of the recent downmove is its preceding of any ECB involvement, and the fact that it has continued despite a stalling in Italian and Spanish 10yr yields at or about the 5% level since the first wave of ECB buying.

… methinks the Shamrock Rovers long-boat effect will kick in tomorrow morning and the ten year will dip below 8.00 –

@ Eureka

1. No. It’ll depend on the cash prive vs coupon mix. All yields are typically quoted on a ‘yield to maturity’ basis. If you bought it at 100 (par), then yes, your annual coupon would be equal to 9%. But if you bought it at less than par (ie 90) your coupon would be lower with a cash ‘gain’ at the end, and vice versa if you bought it at a premium to par (ie 105).

2. Eh, complex. Also depends what you mean by ‘cheaper’ – do you mean a cash price higher/ yield lower relative to par? Thats cheaper to issue, but more expensive to buy, in market speak.

Either way, will depend on coupon on bond vs yield on bond vs prevailing risk free rate. At the moment, with Irish bond yielding well above both risk free rate and prevailing interest rates (ie Bunds and Euribors), they will get more expensive (higher cash price, lower yield) as they approach maturity, assuming rate and credit outlook remain unchanged.

@All

Is there a reliable daily volume source for Govt bond trading?

It all seems a bit hit and miss without at least some knowledge of the underlying volume.

@ aiman

Your contributions have clarified a number of issues for me and I would, in any case, intuitively have agreed with them, even though my knowledge of bond trading is minimal.

One point, however, seems to me to be worth mentioning and that is the contradiction in the position of those stating that default is inevitable, if not actually advocating it. The position itself is totally respectable and I have no problem with those that hold it provided they accept the logical consequences thereof which, even to me as a layman, are obvious; exclusion from the international bond markets for an indeterminate period and the consequent need for an immediate balancing of the budget. The downside of a false debate avoiding these realities is, nevertheless, to undermine market confidence.

In the broader context, I noted among the comments on the Krugman piece criticising the view of Schaeuble that public debt was the cause of the crisis (see other threads just opening) the view that E-bonds existed in reality if not in form for most of the euro’s existence because the spreads between bonds issued nationally were minimal. In other words, the markets did a thoroughly bad job of assessing sovereign risk and one, it seems to me, can safely assume that they are now repeating these errors (the point made by LBS and decried by various commentators on this blog).

Because the markets did a bad job, governments over-borrowed, or based expenditure plans on ephemeral bubble related tax income, and took no action to counter the growth in private sector debt with the result that the two forms of debt have now become inextricably entangled. Ergo, Schaeuble is right.

Meanwhile, back at the ranch, events are moving at a seemingly accelerated pace. Merkel is now to address the Bundestag on 7 Sepetmber, the same day as the constitutional court announces its verdict on the constitutional propriety of Germany participating in the existing EFSF. Clear elements of political choreography are emerging which suggest that there is a good knowledge in the circles that matter of what the judgement of the court is likely to contain i.e. that it will not give a negative ruling on the EU aspects of the matter but concentrate on the supposedly inalienable rights of the parliament in budgetary matters and require that it be stipulated in any implementing legislation that it be involved. As the totally disabling rule of unanimity applies in any case to the EFSF, this may not greatly alter matters.

The FAZ had an intriguing report that Merkel told her party meeting that the ECJ should be able to review compliance with the SGP. If true, this suggests that a major change may be taking place in the view that Germany takes of the so-called “six-pack” of legislative measures in relation to the SGP not so much in respect of the role of the ECJ – which has the right to review the implementation of EU legislation anyway – but on the issue of reverse majority voting i.e. will it be the members states (where Germany, France and others can readily organise the required result) or the institutional procedures (where they cannot) that will decide on the automaticity of sanctions? Watch this space!

http://www.faz.net/artikel/S30638/euro-rettung-wulff-kritisiert-anleihekaeufe-der-ezb-30490517.html

Thanks Eoin and aiman
So would most people buying them be thinking of holding onto them to maturity and getting the 9% or holding them for a shorter time and taking the coupon but selling them for a higher cash price later? That might be a dumb question – I dunno.
Is this a valid viewpoint;
Declining yield might reflect real market confidence that the eventual yield will be paid or might just be people trying to profit on a trend. I suppose the real difference between Ireland and others might be when we have to start paying back bonds. Our next crisis really isn’t until 2013 whereas for the others it will happen sooner. So reality will not test perception in Ireland’s case for a little longer hence the yield decline. It’s a pesimistic view I accept and based on the view that austerity may not narrow the deficit as much as planned

@ CP

just so we’re clear – its not the ECB. Not an opinion, its a fact.

Any new moves from Ireland will in my view be suitably rewarded by the ECB via actual material buying, at the moment the small purchases amount to a carrot being dangled in front of a so-far compliant Irish State.

@ CP/Eureka

its a mix of buyers. Some distressed buyers who just simply think they’re worth a lot more than the 60-70 cents of a month ago, some momentum players (and Ireland is THE momentum play at the moment, though momentum buying isn’t easy in an illiquid govt bond market like Ireland, easier via CDS), and some real money, real size, long term, hold to maturity buying, particularly out of the US. I would say that the perception of Ireland is now far better outside of this island that it is domestically.

@CP – Ireland has an average investment grade rating. One agency only has cut it to junk. My post at 11.20pm yesterday in this thread explains it further, if you’re interested.

Saying “most funds would be constrained” is plain wrong.

Looks like the ECB have moved today to reign in Greek yields. 2 year in 3% to 42.5.

They must be frightening the Greeks into submission….expect some announcement.

@ Cp

“Looks like the ECB have moved today to reign in Greek yields. 2 year in 3% to 42.5.”

I’m sorry, this is something that was noted above – lower yields are assumed to be caused by ECB buying, higher yield is market making a call. Its simply wrong, ECB hasn’t had a sniff at Greece today, the rally is as a result of the full technical terms and conditions relating to the Greek bond swap being released this morning and it appearing to add a few cents to the underlying value of the swap to existing holders (there was always a huge amount of uncertainty around option (4)).

Re – “funds are constrained” – again, contrary to popular belief, lots of funds can still buy junk bonds, which Ireland actually isn’t yet. Money market funds typcially have hard thresholds, but anything with actual risk in it (ie corp bonds, equities, emerging market, property – so therefore most asset managers) doesn’t necessarily have so. I can only state this one more time – real money funds are buying into Ireland. This is not a guess. Please stop counter-guessing actual facts.

@Bond

Would you say that the ECB has now made a mark to market profit on its Irish bond holdings?

If not, how low must they go?

@christy – The short answer is “no”.

If the rumours concerning the timing of the ECB’s purchases of Irish debt are true, the bulk was purchased in the first two or three months of the SMP’s operation in 2010. This would have been at 10 year yields around 5.5%. Losses on bonds of that tenor would currently stand at around 15/20%, depending on allowance for running yield. Losses on shorter-dated bonds would be a deal lower in percentage terms, but still significant.