The Daily Update - Falling Yields Across Europe Ain’t All Good

If you wanted Austria to look after inheritance money for your grandchildren you could make use of Austria’s 100-year bond (now 98-year) yielding just 1.18% (bear in mind that with the magic of compounding this is still enough to potentially triple your money by 2117). But its 2.1% coupon and trading price around €150-€160 serves as a stark reminder of just how far European bond markets have moved over the past two years – where if you locked-in your money for the century back in 2017 there would be as much as 7.6x (given the usual assumptions) waiting for the beneficiary (perhaps for their deposit for a flying car or trip to Mars).

Of course, this creates a dilemma for long-horizon investors, such as pension funds, who can survive a falling yield environment through reaping transient gains but now face the prospect of fewer and fewer investment opportunities that meet their liabilities or targeted returns. The same root issue is increasingly impacting financials’ declining earnings, with some arguing that Deutsche Bank’s woes are primarily a simple profitability issue with ~2% return-on-equity simply not enough to sustain the behemoth. Even their €288bn of longer-dated leveraged assets to be shifted to a bad bank aren’t defunct or in default but mostly just offer too little return in the current regulatory environment – thereby not creating an imminent liquidity or solvency problem but simply a profitability problem – that shows no sign of abating without structural change (or a merger which clearly was even more unpalatable).

Another obvious manifestation of this is the Italian 50-year bond now yielding just 2.84% and maturing in 2067. Italy’s recent political turbulence has been enough to cause concern for the near-term let alone the ultra-long half-century horizon; nevertheless, this particular bond has seen its price rally from €85 at the beginning of June to €104 last week. Inevitably Italy added a further €3 billion to this ultra-long issuance this week, receiving nearly €17 billion in orders and thus being 5.6x oversubscribed. Kit Juckes, head of credit and currency strategy at Societe Generale describes the current scenario as “the shortage of positive-yielding ‘safe’ bonds is still driving investors to overpay for what’s left.” The Catch-22 is that what is good for European sovereigns can be bad for its financials. Thus we continue to see little and decreasing value across Europe alongside significant and increasing risk, whichever way the market moves.

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