It's not quite a zero coupon perpetual sovereign bond just yet, but it will have to do for now.
Having already sold debt which pays zero interest (i.e., 0% coupon), in just a few hours, Germany will sell an ultra-long bond with a 0% coupon for the first time on Wednesday amid a spasm of debt sales over the next two weeks offering negative rates.
As Bloomberg points out, this week’s 30-year auction will test the continued demand for haven assets now that the whole of Germany’s yield curve is in negative territory.
Meanwhile, as Bank of America said in a Monday report, the search for returns has driven 30-year yields to negative levels that cannot satisfy the return requirements of insurance companies and pension funds. This scramble for yield risks a repeat of the bund "tantrum" seen in April 2015 when 10-year yields were approaching 0% for the first time and a Bill Gross warning coupled with a sudden lack of appetite for a debt sale triggered a violent sell-off.
“There are some concerning parallels to today’s market environment,” said Ralf Preusser, global head of rates strategy at Bank of America, in a note. The risk is that at these yield levels, the German Treasury will eventually encounter a “buyers’ strike,” he said.
But not yet.
Germany will sell two billion euros of new 30-year debt at 10:30 a.m. London time on Wednesday, and since the yield on Germany’s 30-year bonds fell four basis points Tuesday to minus 0.18%, much lower than the 0.29% level on July 17, when the nation last sold similar-maturity debt, not only will the bond come with a zero coupon but it will be the first negative yielding ultra-long bond ever sold by Germany.
That said, traders will be closely following the oversubscription rate on the sale, which neared a record low in the July after falling for the last three auctions.
After the 30Y auction, Germany will next sell five billion euros of a new two-year bond on Aug. 27, followed by three billion euros of 10-year notes on Aug. 28 and four billion euros of five-year securities on Sept. 4.
But what if the warnings of a buyer's strike are wrong and investors scramble to buy up even more duration ahead of a barrage of global QE, sending ultra long rates even lower? Well, as Deutsche Bank's Michal Jezek wrote back on July 8, "the German government seems to be getting closer to having the power to issue a zero-coupon perpetuity in this market."
As Jezek further writes, "Last week, the 100y bond of the Austrian government traded with the ask yield of 1.05%. Given the Austria-Germany yield differential at the 30y point is about 35bp, Germany would likely be able to issue a 100y bond with the nominal yield around 0.7%... if one believes that inflation over the next 100 years is going to average close to the ECB target of 2%, Germany could in real terms be paid some 1.3% p.a. for borrowing hundred-year money."
Ok but, a 100 year bond still has some value, even if that value will go to one's grandchildren. What about a zero coupon perpetuity? Isn't that, by definition, worthless as one is just handing over money to a sovereign without ever being owed a maturity? Here are some parting, and quite interesting thoughts, from the Deutsche Banker:
if we were to analyse the valuation of zero-coupon perpetuities, we would find that such securities are generally not worthless. Why would a zero-coupon perpetuity not be worth exactly zero? Because its nominal value adds to the stock of debt of the issuer and so it is an option on recovery value (all pari passu claims get accelerated in default). Paradoxically, the value would rise with default risk, all else equal. So within the Eurozone, an Italian or Greek government zero-coupon perp would be worth more than a German one! On the other hand, Japan's might be less valuable than Germany's despite the mountain of their debt. Japan fully controls the printing press and is thus much more likely to resort to the "soft default" option of inflating debt away rather than ever incur the disruption costs of a "hard" restructuring. Of course, this is an exploration of an abstract concept, we are unlikely to see anyone issuing such structures. Just imagine what the roadshow brochure would have to say!
One thing that was not clear, is in the case of a default, does the perp get converted into equity of the sovereign, and if so, does that make bondholders the new "equityholders" of a European nation? In light of the ongoing diplomatic fiasco between Trump and Greenland, maybe this could be a "clever" way for some aggressive emperor types to moonlight as distressed sovereign investors and eventually equities the entire world, which has so much debt the either hyperinflation or debt default are the only options.