30 BARRON’S September 30, 2019
CURRENT YIELD n By James Grant
A Rendezvous With Zero?
Yields of Austria’s 100-year bonds are falling. What happens when the market turns?
IN 1961, READER CHARLES
Calvert stepped off the
USSShangri-Laandinto
civilian life at the Na-
tionalSavingsandTrust
inWashington,D.C.Lit-
tledidthetyrosecurities
analyst realize that interest rates were
poised for a 20-year lurch to the upside
followed by a multigenerational break to
the downside.
He realizes it now. Like many who
cameofageduringtheinflationofthelate
20th century, Calvert has had the devil’s
own time adjusting to the era of subzero
percentbondyields.Hecan’tgetitoutof
his head that the borrower ought to pay
the lender, not the other way around.
Evenso,almost$15trillionworthofse-
curitiesworldwidearepricedtoyieldless
than nothing. Additional trillions, junk
bondsincluded,yieldnotmuchmorethan
that inconsiderable figure. A Missourian,
Calvertapproachestheinterest-ratesitua-
tion with native skepticism. He writes to
updatethestatusoftheAustriancentury
bond, the double-A-rated, euro-denomi-
nated2.1sofSept.20,2117,thatwerefea-
tured in this space on July 5.
You may recall the yield attached to
thatexotic,ultralongissue—amere1.08%.
Thiscolumnrolleditseyes.Solittleforso
long? Your columnist, age 73, predicted
that he will be in better shape come the
2117maturitydatethantheinvestorswho
doggedly buy and hold those mispriced
pieces of euro trash.
But a funny thing happened on the
road to ruin. In not quite three months,
that 1.08% yield to maturity has fallen to
0.72%.Thepricehasreciprocallyrallied—
no,thewordisleapt—to197.7from161,up
by22.9%.You’dthinkthatthebondwasa
stock.
Intheirprosperity,thebondbullshave
beguntoholditagainsttheweekendsthat
themarketisclosed.SomeexpecttheEu-
ropean Central Bank to keep buying
bondsatever-higherprices,theAustrian
centuries included. Others hope for still
more radical policy assistance. Just the
otherday,MarioDraghi,theECB’soutgo-
ing president, admonished his soon-to-be
former colleagues to keep an open mind
about modern monetary theory, the doc-
trineoflimitlessmonetaryaccommodation.
It is limitless, at least, until an inflation
problemsurfaces,buteventhenacompli-
ant central bank wouldn’t raise interest
rates.Rather,thegovernmentbehindthe
central bank would raise taxes.
Notthatanacceleratingrateofinflation
appears imminent—low birthrates, crush-
ingdebts,anddigitalefficiencieswillseeto
that. “Low inflation,” declared New York
FedPresidentJohnWilliamsonSept.4,“is
indeed the problem of this era.”
Yes, the measured rate of inflation in
Austriais1.5%,morethantwicewhatthe
centurybondsyield.Butastothatdatum,
as well as other fundamental consider-
ations—for example, the strength of the
euro and the creditworthiness of the for-
merAustro-HungarianEmpire—themod-
ernbondmanagermaybeagnostic.Ifyou
run an index fund, you buy the securities
in the appropriate index, no analysis
required.
Anyway, as the bulls see things, every
euro-denominatedyieldstillquotedinpos-
itive figures is a candidate for a rendez-
vouswithzero.Justimagine,theysay,that
today’s72basispointyieldtomaturitybe-
comes tomorrow’s 50 basis point yield to
maturity.Ifso,theAustria2.1swouldrally
to223.7from197.7.A25basispointyield
to maturity would lift the price to 260.6.
And a 0% yield to maturity—well, why
not?—would deliver a price of 306. Bond
folkusedtojokeaboutanimaginedzero-
couponperpetual,asecurityprovidingno
current yield and never maturing. A bull
can dream that Austria might start the
ball rolling.
Calvert leaves the bulls totheirimag-
inings. His conservative approach is the
one that Ben Graham himself prescribed
for investors in senior claims. Because
fixed-income securities pay you par and
thecoupon,atbest,cautionisparamount,
said the father of value investing. Yes,
Graham did write before the advent of
quantitativeeasingbutnotbeforethein-
vention of common sense.
Anyway, our reader muses, imagine
that yields go up, not down, and that the
firststopis1%,or100basispoints,versus
today’s72basispoints.Youwouldthenbe
looking at a drop in price to 168 and
change from 197.7. Nothing you couldn’t
recover from, an optimistic holder might
consolehimself—onlyrecallthepotofgold
at the 0% mark.
But,Calvertproceeds,assumethatthe
1%marketyieldnowbecomesa2%yield,
alongwithacorrespondingpriceof104.3.
Impossible? It was possible enough in
2017,whenthebondscametomarket.Be
thatasitmay,wearenowtalkingabouta
47% plunge in principal value.
Long-dated Treasuries fetched 3.90%
or so on Calvert’s first day of work 58
yearsago,soheseesnothingoutlandishin
theprospectofareturntothatnot-so-ele-
vated yield. At 4% on the nose, the 2.1s
would command a price of 53.6, a loss of
almost 73% from the current level.
At the alpine reaches of 6%, our
reader’s analysis concludes, the price
would fall to 35, indicating a loss of
slightlymorethan82%.Itisadrawdown
onlysevenpercentagepointsshyofthein-
famous 1929-32 plunge in the Dow Jones
Industrial Average.
Calvert claims no gift of financial
prophecy. He says he sold his bonds
many years ago, never imagining just
how far the bull market could carry. He
tips his hat to Lacy Hunt and Van Hois-
ington, prescient bulls at Hoisington In-
vestment Management, but says he is
happier husbanding cash “in plain-vanilla
money-market funds, available to take ad-
vantage of any meaningful corrections in
the stock market.”
“Regardingbonds,”ourcorrespondent
adds, “my policy, to quote from the Fed,
withaverydifferentmeaning,isto‘have
patience’ and wait for a return to a time
when bonds will sell to provide a decent
real rate of return.”
Besides the 2.10s of 2117, Austria is
famous for Sacher torte, Mozart, and a
theory of the business cycle having to do
withtheunintendedconsequencesofcock-
eyedinterestrates.ButitwasanEnglish-
man,LordLiverpool,whoanticipatedthe
Austrian economists in that analysis and
topped them in concisely expressing it.
Here,courtesyofthefinancialcommenta-
torMartinHutchinson,isLiverpool’sun-
derstateddictumaboutthecorruptingef-
fects of loose monetary policy in a fiat
currencysystem:“Thetendencyofanin-
convertiblepapermoneyistocreateficti-
tious wealth, bubbles, which by their
bursting, produce inconvenience.”
Stand by for inconvenience.
JAMESGRANT,founderandeditorofGrant’sIn-
terestRateObserver,istheauthorofBagehot,
thelifeandtimesofthemuseofmoderncentral
banking.
The 100-Year Bet
WiththeEuropeanCentralBankbuyingbonds,Austriancenturybondshaveseentheirprice
surgeover20%,andyieldstumble.Butthatmathcouldeasilyreverse.
Source:Bloomberg
Austrian 100-Year Bond
Oct. ’18 Dec. Feb. ’19 April June Aug.
100
125
150
175
€200