Yield-desperate investors stop before nothing. What have central banks wrought?
Junk-rated, deficit-plagued, inflation-whacked Argentina just sold $2.75 billion of 100-year dollar-denominated bonds. This was the first time ever that a junk-rated country was able to sell 100-year bonds denominated in a foreign currency, or any currency.
Argentina sports a “B” credit rating from Standard & Poor’s. Five notches below investment grade. Deep junk.
And 100 years is a very, very long time for Argentina and its regularly beaten-up creditors: Just over the past 65 years, it has defaulted six times – in 1951, 1956, 1982, 1989, 2001, and its “selective default” in 2014. Its default in 2001 on $80 billion of dollar-denominated debt was the largest sovereign default at the time.
And yet, yield-desperate investors don’t seem to care. According to The Wall Street Journal, demand for the private-placement offering was such that Argentina could sell those “century” bonds at a yield of 7.9%, down from the initial price talk of 8.25%.
They’re priced at about one percentage point higher in yield than Argentina’s 30-year bonds. So yes, in that respect, they’re a good deal.
Argentina will certainly default on them. These bonds are denominated in US dollars. Argentina does not control the dollar; so it cannot inflate or devalue away the dollar bonds, as it can with local-currency bonds. And it cannot print the money to service the bonds as it can with local-currency bonds. Years and decades down the road, Argentina has to earn enough devalued pesos to service its dollar debt. This is precisely what it couldn’t do so many times in the past.
Weeks after it exited its last default, it started borrowing in dollars again. In April 2016, it sold $16.5 billion of foreign currency bonds, the largest-ever sovereign-bond issuance by a developing country at the time (Saudi Arabia later beat that record). So its pile of foreign currency bonds is starting to grow. There is no doubt that Argentina will default again on its foreign currency debts over the next hundred years, and probably several times. The hope is that it won’t do so over the next few years.
For now, given its defaults in the past and the haircuts it imposed on creditors, and having been locked out of the global credit markets for a decade-and-a-half, its foreign currency debts are relatively low. And what investors care about today is today’s yield.
At institutional investors, such as insurance companies and beleaguered pension funds that must earn an average return of 7% a year for all times or go bust, the people who made the decision to buy these things have one hope: Collect the fat yield for a while, personally pocket the bonuses over the period, and then change firms or retire and let someone else deal with the fallout. After all, they’re just managing other people’s money.
Other countries have recently issued 100-year foreign currency bonds, including Mexico – and Ireland, if you count the euro as a currency the issuing country does not control. They all wanted to lock in the super-low interest rates and take advantage of investor desperation. But all of them have investment-grade credit ratings.
Argentina’s Finance Secretary Luis Caputo claimed that the bond sale had been possible because the country had regained credibility in global credit markets. In reality, the bond sale had been possible because central-bank interest-rate repression and asset-price inflation has driven global investors into a state of desperation.
Whatever the future holds for Argentina’s foreign currency bonds, their yields look temptingly juicy today. Its foreign currency sovereign debt has risen 8.3% in value so far in 2017, according to the Wall Street Journal. Yield-chasing global investors, blinded by eight years of central-bank interest-rate repression have the hots for this type of yield, no matter what the risks.
You can’t blame Argentina for those dollar bonds. It’s simply doing what investors encourage it to do.
But no investor should buy foreign currency bonds from Argentina, unless they come with huge yields. Foreign currency bonds regularly lead to debt crises all over the world, not just in Argentina, thus triggering international bondholder bailouts by the IMF and other organizations that then try to impose “austerity” on the country. Instead, Argentina needs to stop monetizing its deficits and get inflation under control, thus building credibility for its own currency – which would take many years, given the shenanigans of the past decades – so that it can rely on issuing peso bonds at a low cost. It controls the peso, and it will never default on peso-denominated bonds.
It does sell peso bonds. But investors exact their pound of flesh in return for exposure to Argentina’s toxic currency. Earlier this year, for example, it issued five-year bonds denominated in pesos at a yield of around 18%. Inflation, at 24% in May on a 12-month basis, will likely eat up the yield, and plus some. So there’s not a lot of appetite among investors for taking this sort of beating on a regular basis.
But that central-bank-imposed low-interest rate environment may not last much longer, at least not in the US. Oh my, how things have changed since late last year. Read… The Fed is on a Mission, Doesn’t Worry about Markets: New York Fed’s Dudley