Italy bond: Methuselah madness

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A bet on QE expansion overrode worries about the referendum for Italy’s 50-year debut.

Issuing a debut ultra-long sovereign bond just weeks before a highly divisive constitutional referendum that could bring down the government would once have been considered a risky thing to do. 

Not today. Italy issued its first ever 50-year bond in October, despite the fact that a populist vote in the December 4 constitutional referendum could topple prime minister Matteo Renzi’s government, in a situation eerily similar to the UK’s Brexit vote in June.

Not only did Italy issue, it attracted an €18.5 billion order book that resulted in a €5 billion deal – far in excess of the €2 billion to €3 billion that the market thought was possible and larger than similar deals for Spain and France earlier this year.

The deal was sold at a yield of 2.85% for 50 years – the same as Italy paid to issue 30-year debt earlier this year and less than it would have had to pay for three-month money five years ago. France’s 50-year OATs were yielding 1.923% at the beginning of October and Spain’s 3.493%.

It is hard to be surprised by anything in Europe’s dysfunctional capital markets anymore, and Italy is simply jumping on a Methuselah bond bandwagon that has been rolling all year. Yes, being paid 2.85% to lend to Italy for 50 years sounds mad, but Swiss 50-year rates turned negative at the end of July so everything is relative.

Distribution shock

What is shocking about the Italy deal is its distribution. Some 45% of the bonds went to fund managers and 23% to banks – no surprise there. But of the fund manager allocation, hedge funds took more of the deal than the pension funds and insurance companies that this kind of ultra-long issuance is specifically designed for. 

There is only one conclusion to draw from that – they are buying the bonds to bet on the chance that the ECB will admit these bonds into its QE programme, which is currently limited to maturities of 30-years or less. Indeed, a rumour that the ECB was considering tapering QE that emerged immediately after the bond was free to trade triggered a price slump from 99.194 to 96.53 in a mere 24 hours. If there is a more obvious illustration of why hedge funds bought this issue, Euromoney can’t think of one.

Extending eligibility to include maturities of up to 50 years could make around €80 billion of new debt available for QE. If the ECB also reduced the short end limit from two years to 18 months this figure would be boosted to €120 billion. Many investors see this as an obvious next move by the ECB and are buying in anticipation that such changes will be announced in December. 

ECB QE is creeping like a virus into every corner of Europe’s capital markets. Data published on October 25 confirm that the central bank is now buying €418 million of corporate bonds a day in additional to its sovereign QE programme. The way that things are going a negative yielding 50-year bond for Italy might be only a few short years away.