Has Argentina confirmed that the bond bull market is well and truly over?

There’s been a lot written about this 100-year Argentinian bond that came out earlier this week.

In fact, I wrote a bit about it in the current issue of MoneyWeek magazine. But I just wanted to revisit it again, because it’s such a beautiful moment.

In some ways, it’s almost too perfect. This is a country that has gone bust eight times in the last 200 years. And five of them were in the last 100 years, which means it’s getting worse, not better.

Now it’s gone and borrowed money over 100 years – because investors were pestering it for the opportunity to do so.

They say they don’t ring a bell at the top of the market.

But surely – surely – this is it?

A Friday morning joke about emerging frontier market debt

Argentina’s latest bond issue will pay out its face value in 2117. By then, barring some Ray Kurzweil-style miracle, everyone old enough to have bought it will almost certainly be dead.

Not that that matters. Because anyone who bought it will no doubt still be around to witness Argentina default on the loan!

Chuckle, chuckle. See what I did there?

At least, this seems to be the reason why the various pundits who are marvelling at anyone lending to Argentina at any rate, for any length of time, reckon that this shows quite extraordinary over-exuberance on the behalf of investors.

I take their point, and it’s not an unreasonable one. A near-8% yield is not to be sniffed at. At that rate, it’ll only take about 12 years for the bond to repay its entire cost of purchase. Yet it still seems to be a little bit keen on the behalf of investors (you can hold a lot of elections and pull a lot of U-turns in 12 years, as we British voters could warn them).

But the real problem with the Argentina bond isn’t so much what happens in terms of the politics and the history of defaults (though those matter too). There are a couple of more mundane, non-Argentina-specific reasons as to why this might be as good as it gets for bond markets broadly. And those are the real reasons why – even at 8% – this Argentinian bond might not be a great purchase.

The real risks of investing in Argentinian debt

Think about it this way. Let’s say you want to lend your money to a global government, and you want to do it in US dollars. Your first port of call is the US. In the world as it currently stands, the US will not default on you. It’s the biggest power in the world and it’s the most reliable credit risk.

Yes, it’s possible that the dollars that the US government repays you with might not be worth what you’d hoped they’d be worth (in other words, you could lose out in “real” terms), but they won’t just turn around and decide not to pay you at all (not yet, at least). That’s why the yield on US Treasuries is sometimes known as the “risk-free rate”.

So if you decide to lend to someone other than the US government, then you have to get paid more than the US government is offering to pay you. The gap between what the US will pay you, and what someone else will pay you, is known as the “credit spread”.

When people talk about credit spreads tightening or widening, what they mean is that the yield investors demand to buy riskier countries or corporations than the US government, is getting smaller (tightening) or getting bigger (widening).

So the real risk here is not so much whether Argentina defaults or not. They might have historically been a bad credit risk but the country is unlikely to stiff its creditors tomorrow.

The real risks are different. One is that the US economy does fine, inflation really does tick higher, and the Fed keeps raising interest rates. That means two things. Firstly, the yield on US Treasuries will go up, which means that – unless credit spreads tighten – the yield on Argentinian bonds will have to go up too, and the price will consequently fall.

Secondly, and more importantly, higher interest rates would probably mean a stronger US dollar. That would make it more expensive for Argentina to pay the interest on these bonds (remember, they’re dollar bonds and Argentina has to turn pesos into dollars to pay the interest on them). In turn, that makes the bonds a bit riskier and again, would drive up yields and push down prices.

The other danger is that the US economy doesn’t do well. In fact, you end up with another deflationary scare. That would drive down US yields and drive up prices of US bonds. “But, wouldn’t that then drive down yields on Argentinian bonds too?” I hear you exclaim.

Ah, no. You see, if deflation hits, everyone will be scared. They will rush for “safe haven” assets. US Treasuries fall into that category, and gold would probably get a bounce too (the Swiss franc and the Japanese yen usually enjoy that sort of thing as well).

But Argentinian bonds are not a “safe haven” by any stretch of the imagination. Instead, what would happen is credit spreads would widen (or even “blow out”, depending on how bad things got) and so, again, markets would demand higher yields on the Argentinian bonds and the price would fall.

As BlackRock’s Sergio Trigo Paz puts it in the FT, “it doesn’t look good either way”.

So the basic problem is that if the US economy gets a lot better or a lot worse any time soon, this bond might not look so clever.

And sure, if you say today that you’re willing to hang on to it for 12 years, you might do OK. But I’ll be interested to see how keen you are on that plan when the bond is in free fall along with other emerging and frontier market debt, or when in three years’ time, all the economic reforms are faltering and the shine is off the new president, or any other number of things that can happen over that time.

In short, this may not be quite as mad as it looks from the outside. But it’s still only the kind of thing you could get away with in a market that’s much closer to the top than to the bottom.