Thursday 23 November 2017

Q&A: Bonds

Thomas Molloy

Thomas Molloy

Thomas Molloy answers your questions about recent developments in the bond market.

What is a bond?

A bond is simply a loan to a country or a company. When a country borrows money, it usually promises to pay back interest every year, as well as the sum borrowed at a certain point in the future. It can be much more complicated, but most bonds are a variation on this.

And what is the bond market?

It is the huge group of investors who buy and sell bonds every day. While a lot of attention is paid to the stock market, the bond market is much bigger and much more important. "I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone," is how ex-US president Bill Clinton's adviser James Carville once put it.

But why is the bond market so intimidating?

If the markets decide they don't trust a small country, then that country can run out of money very quickly. The number of people interested in lending to Ireland is fairly small. We have to keep this select group happy if we are to continue living beyond our means. Even Mr Clinton spent much of his first term in office trying to please the markets and disappointing supporters.

So who is lending us money by buying our bonds?

A mixture of pension funds which like the reliable income stream and governments in countries where people still actually save money rather than borrowing it. Very few Irish funds invest in Irish bonds. Most Irish bonds are bought by overseas funds.

What happened yesterday?

The National Treasury Management Agency (NTMA), which sells Irish bonds on behalf of the Government, sold a fairly routine six-month bond. It was nothing special, there are two auctions of these so-called treasury bills, or T-bills to use the jargon, every month. Rather unexpectedly, investors got so worried about the state of the economy that they demanded almost twice as much money to buy the bonds, compared with three weeks ago. The average interest rate demanded yesterday was 2.46pc, compared with 1.36pc on a similar bill in July.

That's scary. What went wrong?

We don't know yet. Perhaps the investors are freaked out by Anglo as well as the losses from AIB and BoI reported during the past few days. Or perhaps the explanation is simpler; it is August and any self-respecting Master of the Universe is lying on the beach in the Hamptons or St Tropez. The real test comes next week when the NTMA tries to raise another €1.5bn by selling a four-year bond and a 10-year bond. Last month, it had to promise to pay an interest rate of more than 5pc to borrow money for this type of bond, which is already very high.

To be honest, 5pc doesn't sound bad. My credit card is 19pc

Yes, but you aren't a country. Germany is paying 2.4pc which means we are paying more than twice what the Germans pay to borrow money. Besides, most experts believe anything over 5pc is unsustainable. We've been borrowing money at an unsustainable rate for sometime now. It can't go on.

When's the next auction?

Tuesday. It will be a moment of truth for our leaders. If we have to pay anything close to 6pc or if it is cancelled you should be very afraid. Ignore what the NTMA says about the auction being oversubscribed, demand being strong; that's just blah, blah, blah. What matters is the rate we are forced to pay.

Could it be cancelled?

The NTMA is saying it won't be, but it will be holding intense talks with the usual suspects over the next few days to make sure they are bidding. Like any auctioneer, the agency usually has a good idea of what will happen before the auction begins.

So where do these auctions take place?

Over a computer system owned by Bloomberg, the company set up New York mayor Michael Bloomberg. There are no smoke-filled rooms any more.

What could we do to bring down the price we pay?

Tell the world how much Anglo will cost. Right now it is a blank cheque that the bond markets don't want to pay. Restore the banking system so that it functions. Get the public finances in order by slashing spending so that borrowing falls. That's the sort of thing the bond markets want.

Irish Independent

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