‘Fascinating’ is not a word often heard in connection with a Latvian bond issue. Yet that is how debt bankers described the Baltic country’s mandate for a new deal last month.
The unprecedented excitement is because, as of mid-March, Latvia’s 10-year bonds were yielding 0.5% – that is to say, a former Soviet state with a common border with Russia, which only joined the eurozone in 2014, was trading well inside European Union founder member Italy.
For bond bankers, however, the real surprise was not the secondary market yields but the idea that a new deal would have to come at those levels. Some doubted it could be done at all. No one, they said, would buy Latvian bonds at yields of close to zero. Emerging market funds would never accept such low returns, while conservative rates investors would be scared off by Latvia’s geopolitical risk.
This obviously raises the question of why Latvian yields fell so far in the first place if there were no buyers. The answer, say sceptics, is that the secondary levels were skewed by lack of liquidity – Latvia has only a handful of euro-denominated bonds outstanding – and therefore failed to reflect fair value. Latvia would therefore have to pay a substantial premium over secondaries to get a new deal done – and even then might struggle to attract investors.
While superficially persuasive, however, these arguments are wide of the mark. For one thing, the idea that the Baltics are geopolitically exposed is a red herring. The supposed risk is of a Russian invasion – but if Vladimir Putin were actually to launch an attack, covert or otherwise, on an EU and Nato member, then investors would have more to worry about than their Latvian bond holdings.
The more cogent threat to Latvia, as to the rest of the eurozone, comes from Greece. Yet in this respect the Baltics are less vulnerable than the southern periphery. A Greek exit would raise fears that Portugal, Spain or even Italy might follow. Yet if it came to a split into core and non-core countries, the Baltics’ proven commitment to fiscal discipline and structural reform would almost certainly ensure them a place in the former camp.
And for the bonds of core eurozone members, fair value will be German yields plus a liquidity premium – which is where Latvia’s debt is trading. It is true that these levels are extremely low and that it will be interesting to see who buys a new issue. QE will clearly be a factor, either directly or indirectly, if investors buy in the hope of selling on to the ECB – but one way or another, the idea that a dramatic fall in yields equates to a shortage of buyers is clearly misguided.
Bankers may worry whether bond buyers will be able to adjust to a new investment climate post-QE. In reality, they are the ones who need to do so.