The price of government bonds below 50 cents underlines investors’ concerns

(Bloomberg) — Fifty cents on the dollar is a very low price in the world of bonds. In most cases, this signals that investors believe that the seller of the debt is in such financial distress that it could become insolvent.

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When a US government bond fell below this price on Monday, it caused a stir. The security, due in May 2050, briefly fell as low as 49 29/32, falling below the 50 cent mark for the second time in the last two months.

Of course, the USA is in no danger of becoming insolvent in the foreseeable future. Government bonds are generally considered to be the safest government bonds in the world. What the price illustrates in this case is the extent of the pain inflicted on investors who piled up longer-term debt at rock-bottom interest rates during the pandemic, only to be caught off guard when the Federal Reserve delivered its most aggressive monetary tightening in decades.

The bond due in 2050 is particularly hard hit because its interest rate of 1.25% is the lowest ever paid on a 30-year Treasury bond. Last month, investors received over 4% on 30-year notes.

“These bonds have coupons that are below market price, and investors need to be compensated for that,” said Nancy Davis, founder of Quadratic Capital Management.

Treasury bonds with maturities of 10 years or more – which have the highest price sensitivity to changes in interest rates or maturity – have fallen 4% this year after a record 29% decline in 2022, according to data compiled by Bloomberg . That’s more than twice as many losses in the overall Treasury market, the data shows.

30-year bond yields hit an all-time low of 0.7% in March 2020 before rising to a 12-year high of 4.47% last month. They were at 4.4% on Monday.

The story goes on

The Treasury initially sold $22 billion of the 2050 securities at about 98 cents (it subsequently conducted two so-called reopenings, increasing the amount outstanding). Since the bond’s introduction, it has rapidly lost value as newer bonds were sold with higher coupons.

The Fed is the largest investor in this debt, with a stake of about 19%, a legacy of its bond-buying program known as quantitative easing. Other buy-and-hold investors such as exchange-traded funds, pensions and insurance companies also dominate.

Of course, should a decline in inflation lead to a decline in long-term yields, these bonds would just as quickly become an outsized winner relative to the rest of the yield curve.

In addition, they have at least one other attractive property for investors. Because of the steep price discount, the securities exhibit what is known as positive convexity, meaning that the price rises more than it falls for a given change in yield.

For example, bonds would rise by about 11 cents if their yield fell by 100 basis points. If yields rose similarly, bonds would only fall by about 9 cents.

“They have very positive convexity, which makes them very interesting bonds, although liquidity is probably very low,” said Mustafa Chowdhury, chief interest rate strategist at Macro Hive Ltd.

(Updates with investor comment, trading levels from fifth paragraph)

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