Debt markets

Published: December 2 2009 09:29 | Last updated: December 2 2009 15:52

Governments, banks and corporates are issuing more longer-dated bonds, in a sign of
increased confidence among investors on the prospects for the global economy.
The shift towards longer-term bonds is expected to reduce refinancing risks in 2011 and
2012, easing worries that a build-up of maturing debt might make it more difficult for
governments and companies to renew loans.
Issuance of longer-dated bonds maturing over 15 years or more has risen to 20 per cent
during the past three months, compared with 10 per cent in December last year, according
to Dealogic.
By contrast, issuance of shorter-dated bonds maturing in under five years has fallen to 30
per cent since September 1, compared with 58 per cent at its peak in December 2008.
Because longer-dated securities are considered more risky than shorter-dated bonds, the
shift signals improved investor sentiment.
Only two cheers for the fact that governments and companies are issuing more long-dated
debt. On the one hand, it is a welcome return to market normality. After all, you cannot
expect roads and schools and companies investment plans to be financed solely with 90day money. But it is also bad in that longer-dated debt is more expensive. That is
especially so at the moment, given the steepness of the yield curve. Companies might be
able to afford the extra cost. Governments cannot.
A back of the envelope calculation shows how painful those extra costs might be. During
the financial crisis, governments have disproportionately funded themselves with bonds
that have maturities of less than a year. A decade ago in the US, for example, a fifth of all
bonds held by the public was short-dated money. Now its a third. This has had some
benefit. Given that short rates are effectively zero, it reduced the US governments
blended interest cost to around 2.5 per cent Assume a normal term structure, however,
with more long-dated bonds, and the USs interest cost would have been about 3.2 per
cent.
That increase would cost $45bn a year, or 0.3 per cent of gross domestic product. For the
UK, the extra cost would be about 0.4 per cent of GDP. As for Japan, the worlds most
indebted country, if it had to finance itself solely with bonds instead of bills, then its
interest cost might be a whole point of GDP higher. Such numbers are a worry on their
own. But they could also have a snowball effect. As maturities are extended and
government debt costs rise, investors might start to demand higher yields to compensate
for the extra risk, which would increase debt costs further, and so on in a vicious circle.
The return to normality comes with a cost.