Double Trouble for Europe's Bond Savior
Europe's savior has run into a brick wall.
The European Financial Stability Fund on Tuesday encountered a stunning lack of investor appetite for its long-end debt. It marketed a dual-tranche issue of 4-year securities and a 39-year bond, and investors piled into the first, while barely glancing at the second.
The pricing was also something of a disappointment, as the spread of 60 basis points over mid swaps for the 39-year was a far cry from the 4 basis point spread it achieved for a 30-year issue in 2015. The recent widening in French spreads over Germany, a common reference point, is clearly making life harder.
At least they saw it coming. After a disappointing outing earlier this month for a 26-year deal, the EFSF hedged its bets by offering both short- and long-dated debt, a technique used recently by Finland and Belgium to protect against insufficient demand for extended maturities.
But the timing is pretty poor. The EFSF and its sister fund, the European Stability Mechanism, are to switch tens of billions of euros of Greek bank aid from short-end floating-rate debt to fixed, ultra-long maturities. The aim is to cap Greece's long-term funding costs at 1.5 percent or less, as recommended by the International Monetary Fund in its debt sustainability review. 1
Having promised a lot of long-term fixed-rated debt to effect the exchanges with Greece, the ESM/EFSF have already anticipated entering into interest-rate swaps to lock in their funding costs. 2 That's pretty normal.
But the funds' present difficulties in issuing long-term debt create a problem. If and when interest rates rise in the future, their cost of selling bonds due in 30 years or more can be a lot higher, and it's hard to know how much. To avoid what could be a substantial hit, the funds will set up the interest-rate hedges they'll need anyway now.
Unfortunately because they're doing so much, that will steepen the euro yield curve pretty quickly, and raise borrowing rates for everyone at the long end. It's just a matter of how they like their pain -- but at least by doing it this way, they can get some certainty on their costs.
And this underscores a much wider problem for European government and related agencies' debt for 2017. There's a huge amount of ultra-long issuance planned but investor demand does not look to be there. Either issuance plans change or funding costs at the long end will have to rise substantially for everyone. Europe can ill-afford a higher bill for its never-ending crisis.
Download this report and see p. 54 https://www.imf.org/en/Publications/CR/Issues/2017/02/07/Greece-2017-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-the-44630
See section 6 here: https://www.esm.europa.eu/press-releases/explainer-esm-short-term-debt-relief-measures-greece
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