Its price will crash if interest rates rise. But most buyers won’t live long enough to regret it
NO ASSET SHOULD be sleepier than the sovereign bonds of rich countries. In exchange for holding “risk-free” debt, investors accept low returns. In real terms, American ten-year Treasury bonds have returned just 1.9% a year since 1900, compared with 6.4% for shares. Since 2017, however, one bond issued by one rich country has returned a whopping 75%.
The country is Austria, and the coupon on the bond is just 2.1%. The secret to its success is its unusually long term. Lenders will not get their principal back until 2117, 100 years from the date of issue.
One of the main determinants of bond prices is the gap between their fixed coupons and prevailing market rates. If a bond is sold at a 4% yield and rates fall to 2%, its price will rise, since it produces twice the income that new securities do. This effect is modest for bonds near maturity. But over 100 years, this two-point gap is multiplied by 100 payment periods. As a result, ultra-long-dated debt is highly sensitive to jitters in interest rates. When rates dip, its price soars; when they surge, its value plunges.
In the past two years, the yield on Germany’s ten-year bond has fallen from 0.4% to -0.6%. Rather than pay Germany to hold their money, some lenders have flocked to Austria’s “century bond”, which yields 0.9%. Long-term rates are now so low that America’s treasury secretary has said the country may sell its own 100-year debt.
The bond’s returns have drawn broad attention. For years, analysts thought that the floor for interest rates was 0%, because creditors would rather stash cash under mattresses than accept a negative rate. Now that negative rates prevail across Europe, this theory has been disproved. And the Austrian bond is the most potent tool to bet on a further decline in rates. If the ultra-long-term market rate fell by 1.1 percentage points, the bond’s value would double.
Rates may not have hit bottom just yet. In Europe economic growth is sluggish, and inflation has been tame. Germany’s GDP shrank by 0.1% in the second quarter. As The Economist went to press, the European Central Bank was poised to cut rates, and possibly resume quantitative easing.
In the long term, demographic change weighs on interest rates. Longer lifespans and falling birth rates mean that Europe’s population is ageing. This shrinks the workforce, slows GDP growth and reduces returns on capital—and thus bond yields.
However, such trends may not hold up for ever. Nor can investors be sure of the survival of the euro, or of Austria’s political stability. A century before the country issued its 2117 bond, the Austro-Hungarian emperor was facing defeat in the first world war. Argentina also sold a century bond in 2017; its price has fallen by 55%.
Moreover, the Austrian bond offers no room for error. Long-term rates have been low for most of history. In 1800-1950 Britain paid around 3.5%. But they have never settled below 1%, the level that today’s investors need to profit. If ultra-long rates rise to 2%, the bond would lose 40% of its value; at 5%, its price would fall by 75%. Lenders seeking safety may face a rude surprise.
Sources: Datastream from Refinitiv; Bank of England; Federal Reserve Bank of St. Louis; Bloomberg; OECD; The Economist