The government has just concluded another highly successful bond issue attracting over €326 million of interest from a variety of institutions as well as the public at large. Confidence in our own government and its finances remain at a high while yields on government bonds continue to remain at extremely competitive levels – eat your heart out Portugal, Ireland, Greece and Spain. Malta pays five per cent on its 20 year bonds vs over seven per cent for 10 year bonds from these countries.
A quick analysis of the applications received by the Treasury for these bonds highlights some interesting trends. Interest in these bonds was split across both issues but on this occasion the bias was very evidently in favour of the shorter dated 4.25 per cent MGS 2017 bond with almost 74 per cent of applications favouring the 2017 bond vs the longer dated 5.25 per cent MGS 2030 bond.
In contrast to the last MGS issue in November 2010 the total amount of bonds applied for includes a very substantial element of “institutional” investors whereas the November 2010 MGS issue attracted such a substantial amount of applications from the public at large that the government was no longer in a position to entertain applications from institutions.
Both the institutional and retail portion of the February 2011 issue show a clear trend. Applications for the 5.25 per cent MGS 2030 from the public amount to €55.2m, down from €146.4 million in November 2010 whereas applications from institutions were also heavily skewed towards the shorter end with applications of €188.5 million vs €30 million in the 2030s.
Is there more to read in this trend than meets the eye? To my mind in looking forward to see what may happen to bond prices one needs first to look back to see where we have come from.
For many investors, investing in bond markets has meant an almost sure way to make money. This has largely been due to the 20 year bull market that government bonds have been in. Over this period, German government bonds(as a proxy for euro government bonds) have seen their yields fall from over nine per cent (yes a mouth watering nine per cent on AAA bonds, in September 1990) to the current yield of a little over three per cent – this after hitting a low of 2.1 per cent in August 2010. Over this period central bankers have been tremendously successful in bringing inflation down to below two per cent.
More recently the effects of the financial turmoil in 2008 has forced central bankers hands to bring interest rates to unnaturally low levels in a bid to stimulate economies back into growth. Policy makers resolve to ensure a strong and sustained recovery has led to unprecedented levels of stimulation through QEII. The signs are positive here.
Economic growth across the developed world is gaining traction and, as the velocity of money increases, as the recoveries gather steam, the spectre of inflation is now rearing its ugly head. Commodity price inflation is feeding through to prices on the high street. The population shifts in the world are unlikely to slow this down and though it does not appear that we are to see a return to the commodity price inflation of the 1970s, clearly the risks are to the upside.
The implications for bonds are therefore significant and worrying. In my opinion 2010 is likely to have marked the low in yields. Investors are starting to demand higher yields to compensate for the prospect of stronger growth and higher inflation. The rise in yields over the past five months is the beginning of a new long term trend that is likely to end in higher rates. Investors may need to learn a painful lesson therefore that bond prices can and do fall – sometimes significantly if the bonds held are long dated or perpetual bonds.
The shocking events of the past few days in Libya complicate matters further. Libya accounts for some two to three per cent of world oil production. The spike in oil prices, if sustained, will act as a significant drag on economic growth. Furthermore, given the human element, one can only hope that developments in Libya can come to a peaceful end without further bloodshed.
Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article has been prepared by David Curmi of Curmi and Partners Ltd, and is the objective and independent opinion of the author. The information contained in the article is based on public information. Any opinions that may be expressed here above should not be interpreted as investment advice, nor should they be considered as an offer to sell or buy an investment. The company and/or the author may hold positions in any securities that might have been mentioned in this report. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
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Mr Curmi is managing director of Curmi and Partners Ltd.