They were dubbed the Sleeping Beauties — bonds that would remain locked away for a century before being repaid. In 1993, the Walt Disney Company sold $300 million worth of corporate paper maturing in 2093. The fundraising by the House of the Mouse, meant in part to pay for its theme parks, was an audacious one, sealing in for decades the unusually low borrowing costs of the time.
Investors lapped the Beauties up, but America’s bond market was not destined to remain in a state of somnolence for long. The following year, traders were jolted awake as the Federal Reserve started increasing its key interest rate. Yields on US Treasuries spiked horribly as investors fled, spooked by the spectre of inflation, in a bear market that is still remembered with a grimace on Wall Street.
George Osborne had his own Once upon a Dream moment last week, floating the idea of a 100-year gilt. The Treasury’s cost of borrowing has not been this low since Victorian times. Given the propitious circumstances, the Chancellor, it seems, hopes to lock low rates in for generations to come.
The problem is the signal that Mr Osborne’s initiative has sent. If the Chancellor wants to capitalise on super-cheap rates now, it suggests that he thinks they will not stay this low for much longer. That’s a worrying message for a bond market where prices are being artificially inflated by official policies that have created a potentially destabilising bubble. With inflation consistently above target and negative real interest rates eroding bond investors’ money, it is hardly possible to argue that gilts offer good long-term value.
Gilt prices retreated over the course of last week. The declines, and consequent increases in yields, were modest in the grand scheme of things, but they reflected in part the ripples of disquiet caused by the prospect of “Osbonds” and fears about the sustainability of gilt prices.
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The Chancellor is expected to announce a consultation on his 100-year paper in the Budget on Wednesday. This will be cast in the context of effervescent demand for gilts, which Mr Osborne argues is a reflection of investor faith in his deficit-cutting plans.
This claim is only partly justified. The creation of an Office for Budget Responsibility, monitoring a set of ostensibly strict fiscal rules, has undoubtedly impressed the City of London. The coalition may be fractious, but it appears to be holding together — in part because of the bleak fate that awaits the Lib Dems when they finally face the polls. The relative appeal of Britain when set against the dysfunctional mess in euroland has prompted safe-haven flows into gilts.
But quiescent yields are not merely a reflection of City admiration for the austere Mr Osborne. Government borrowing costs are ultra-low in the United States and the UK because the market is being propped up by the Fed and the Bank of England’s money-printing.
In Britain, Sir Mervyn King and his Monetary Policy Committee will soon have gobbled up nearly a third of the stock of gilts under the £325 billion quantitative easing scheme.
The Governor told MPs last month that there was largely no limit to how much he could buy, given that the Debt Management Office is continually manufacturing fresh gilts for the Bank to consume. The Bank has signalled that official interest rates will be kept on the floor, which also sustains the downward pressure on yields.
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The official justification for QE is to strengthen growth, but it is a quasi-fiscal operation. Charlie Bean, one of the Bank’s deputy governors, said as much in 2009, when he argued the programme was “reducing the cost of financing a given budget deficit”.
What matters most to the gilt investors is not so much Mr Osborne’s fiscal rules, which are more flexible than they first appear, but the willingness of Threadneedle Street to continue printing money.
This leaves the bond market in a far more fragile state than the Chancellor would have us believe. The Bank has repeatedly assured the public that an exit from its ultra-easy monetary policy will be simple to achieve. This is palpable nonsense.
A sale by the Bank of gilts, coupled with an increase in interest rates, could well provoke 1994-style convulsions in the bond market if mishandled. It is not for nothing that the Bank devoted two pages of its December 2010 Financial Stability Report to examining that episode.
The Bank will therefore come under political pressure to delay its exit from QE for as long as possible — even if it further endangers its already degraded inflation-fighting mandate.
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Mr Osborne’s 100-year bond gambit, which leaked out during a Downing Street field trip to Washington, smacks of hubris. The gilt market has to date remained disarmingly tranquil, notwithstanding Britain’s 8 per cent of GDP annual budget deficit. But an ugly awakening could well be lurking around the corner.