Bond Markets Hit Another 'Ukrainian Chicken Moment'

Signs of excess and distress echo the run-up to the financial crisis.

Two European companies -- French drugmaker Sanofi and German household products maker Henkel -- last week became the first firms to persuade investors to pay them to borrow euros. By selling bonds yielding minus 0.05 of a percentage point, they may well have signaled the bond market's peak, delivering this decade's equivalent of the "Ukrainian Chicken Farm Moment."

QuickTake Negative Interest Rates

That phrase refers to the 2006 sale of $250 million of bonds by Myronivsky Hliboproduct which, according to its description on the Bloomberg terminal, is "a vertically integrated producer of poultry products in Ukraine." Few investors had ever heard of the Ukrainian chicken breeder, but with an interest rate north of 10 percent, buyers were clamoring for the MHP bonds. Bill Blain, currently at Mint Partners in London, was one of the bankers who brought the deal to market. He recalls the bidding frenzy:

It was massively oversubscribed. A few weeks later, bird flu broke out in Hong Kong. The chicken farm was uninsured. The market immediately discounted the notes and the price crashed 30 percent or more. That moment of supreme belief when anything is possible in the new issues market will always be remembered as "The Ukrainian Chicken Farm Moment."

An investor who buys some of Sanofi's 1 billion euros ($1.12 billion) of bonds and holds them until they're repaid in three years is guaranteed to lose money. The same goes for owners of Henkel's 500 million euros of two-year notes. It's the equivalent of lending a dollar and five cents to your neighbor, knowing that you'll only be repaid a dollar. It's further evidence, if it were needed, that the negative interest-rate policies being pursued by policy makers, including the European Central Bank, are making areas of the financial markets look increasingly similar to conditions prior to the financial crisis of almost a decade ago. Then, as now, investors trying to boost returns in a low-yield environment loaded up on risk. Today's negative-yielding bonds are the equivalent of the highly-leveraged derivatives that were all the rage in the middle of the last decade.

Tim Price, who manages the VT Price Value Portfolio, sees these as strange days indeed:

By a happy coincidence, Henkel makes Persil laundry detergent, and Sanofi makes treatments for cardiovascular disease. So any affected `investors' dumb enough to have bought those guaranteed loss-makers and then suffered immediate regret won’t have to look too far for a remedy.

Bond-market yields around the world have started to rise in recent days. The benchmark U.S. Treasury yield has climbed to 1.7 percent from 1.54 percent. Ten-year German yields, which have spent the past three months below zero, have returned to positive territory, stoking concern that investors may be at the beginning of a rout similar to the one that began in April 2015 and drove yields all the way up to 1 percent in less than two months:


There's another corner of the corporate bond market that's in even deeper trouble. Payment-in-kind bonds, a form of debt that allows borrowers to defer interest, were a casualty of the financial crisis as investors learned to their cost that higher returns are typically accompanied by taking on extra risks. Appetite for the securities, which hand investors extra notes instead of coupon payments, has been recovering in recent years, with 2016 on track to beat $11 billion of issuance, topping 2014's total. The recent selloff in fixed income, however, has trashed the value of PIK bonds sold at the start of last week in a matter of days, reminding holders how quickly complex securities can lose value when sentiment turns. 

The mood music currently playing in the bond market is eerily reminiscent of what preceded the bankruptcy of Lehman Brothers and the financial destruction that followed. Back then, the financial community was sleepwalking into disaster, with few investors sounding the alarm bells until it was too late. Now, though, there's a chorus of smart investors pointing to the risks of complacency; as recently as Aug. 31, bond guru Bill Gross warned that investors were "treading on thin ice." It may turn out that paying for the privilege of lending to a European drug company makes about as much sense as handing your money to a Ukrainian chicken farmer.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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