So Australia is about to issue its first ever 30-year bond. The securities, which will pay about 3.2 per cent per annum until March 2047 are, sadly, going to live longer than many of us.
But why is Australia planning to issue such long term debt and why are investors likely to commit money for such a long period of time?
First – let us rule out a reason for issuing billions of 30 year debt. This 30-year bond is not an evil scheme for the government to burden the next generation with debt, as some have suggested.
Governments and companies that require debt funding face a trade-off. They can either issue short-term debt at lower interest rates, but are required to refinance or repay the debt in a shorter time frame, or pay more for longer term debt, and have the luxury of time to repay the debt.
The global financial crisis taught many Australian corporate treasurers a harsh lesson about a short term debt book. As debt markets conditions changed many companies were reliant on three year bank debt, and without access to the quantum of debt at an affordable price they were forced to raise expensive equity capital, hurting shareholders.
For governments the risk is not as stark. But by raising longer-term debt the government can take advantage of historically low interest rates, and lock them in more many years.
This leaves the government with less debt that needs to be refinanced every year, and leaves the budget less exposed to changes in interest rates.
But it comes at a cost. If the government were to issue $3 billion seven year debt (the average maturity of its portfolio) at the current rate for that debt of 1.9 per cent – it would cost $57 million. The 30-year bond is going to cost about $96 million, about $40 million more per annum.
Hence, the AOFM, which manages the government's debt book must constantly balance the cost of long-term debt versus the benefits.
But there's another important reason to issue more 30-year bonds, which are an important building block of other major bond markets.
With more active trading to set the cost of 30-year Australian debt, the deal will provide an important benchmark for other entities, such as those managing infrastructure assets, to raise long term debt themselves.
Infrastructure assets such as ports, railroads and airports are long term in nature and are best backed by long term debt rather than short term debt that is constantly refinanced.
That explains the supply of these bonds but what about the demand?
There are many reasons why investors would consider buying such long-dated bonds. An expected source of demand is from life insurance companies.
These investors have long term liabilities – they know ahead of time how much money they will need in the future – so they're happy to lock in a rate for a long time and not worry about for years, even decades.
They're a prime audience for these 30-year bonds. And life insurers in Japan and Germany where 10-year rates are around 0 per cent, a 3.2 per cent yield on an Australian government bond looks juicy.
Long term bonds also have another quality – high duration – or extreme interest rate sensitivity. Just a small change in the 30-year bond rate can have a big swing in the price of the bond. A half a per cent change in the rate can result in a 10 per cent move in the price which factors in three decades of interest rate payments.
This makes long-term bonds very risky. But not if you believe interest rates are going to fall, or if you're looking for a hedge against a sluggish economy and resultant lower rates.
If this bond was issued three years ago, those that bought it would be sitting on double digit equity-like gains.
Amid all the discussion about bonds being risky and fully priced, there's no shortage of domestic and global investors that believe rates are staying low, or going lower still.
A 30-year Australian government bond is almost the perfect instrument for them to exercise this view.
