One of my grandfather’s mentors was Austrian economist, Friedrich Hayek. Both men are turning over in their graves, as the rules of capitalism appear to be on hold throughout the Eurozone debt markets.
Bank of America Merrill Lynch and Goldman Sachs (amongst other underwriting syndicate members) are reveling in delight this week. Swindling €3.5Billion from global investors with a 100-Year bond issuance from Austria yielding 2.11%, the deal was more than three times oversubscribed. There’s nothing more absurd than capital market discrepancies and such high demand for them. The U.S. Treasury currently yields (as of 09/12/17) 2.14% for 10 years. How can anyone get excited about receiving this same rate of return for ten times the amount of time?!
There’s one answer I can offer: investment bankers are experts in the “dog and pony show”. As a former i-banker from back in the day, memories of exciting broker/dealer’s city to city and touting the brilliance of some great issue or offering, are painfully seared into my memory. Clearly, the Goldman and Merrill teams are at top of their game.
Austria’s core inflation rate has been logged at 2.20% (see chart). This means that the real return to an investor in this 100-Year Austrian bond issue (here, real return includes return on investment net of inflation and taxes, assuming Austria’s top bracket 55%) would be a negative –1.04% per year. Should the current market conditions persist, this bond investor is guaranteed to erode their purchasing power, every year, for the next 100 years.
The alternate math is very scary. Assuming the top tax tier and a similar long-term inflation rate, the buyer of this bond if held to maturity would be destined to lose 65% of their capital investment in real return terms. The only way this deal makes sense is if you believe interest rates are headed down further and inflation is heading lower. However, neither scenario seems possible given the current status of all the major central bankers’ highly correlated balance sheets.