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Bear bites back in bonds Back  
1999 will be remembered as the year of the Good, the Bad and the Ugly in the Irish bond market.
As this is the festive season we start with The Good, taking readers back to last May when the National Treasury Management Agency carried out a very successful bond exchange programme.

With the launch of the euro at the start of the year, the NTMA recognised that a major initiative was required to bring the Irish market more into line with the main governments bond markets in the euro-zone. In particular, there was a need to improve liquidity by pushing the issue size of benchmark Irish bonds up to around _5 billion.

Thus, the NTMA offered to switch about 80% of outstanding issues into four new jumbo-sized benchmark bonds. The take up by investors was very impressive at over 90 per cent, guaranteeing a very successful bond exchange programme. The low coupons on the new bonds proved particularly popular with investors. At this stage, the new benchmark 2010 stock has an issue size of over _6 billion while the new 2005 benchmark bond is approaching _5 billion in size.

The Bad is that an aspect of the advent of the euro has been a decline in turnover in small European bond markets including Ireland. Trading activity is being concentrated much more in the highly liquid German bund market. The advent of the euro has also resulted in portfolio diversification out of Irish bonds by domestic institutional investors as they move from Irish-pound based to euro-based benchmark indices.

The net result is that particularly in regard to the public finances. The Irish 2010 and 2016 bonds for example, are offering a yield pick-up of 25-30bps over similar maturity German bonds.
On The Ugly side, 1999 proved to be the second worst year this decade in global, fixed- income markets. Three factors contributed to a severe setback in bond markets: (i) emerging markets stabilised in 1999 so the flight to quality into bonds evident in 1998 unwound (ii) inflationary expectations rose as growth in the world economy bounced back strongly and oil prices surged and (iii) there was an unexpected tightening of monetary policy by central banks, most notably the US Federal Reserve.

The result has been a sharp rise in yields and large fall in bond prices. The US long bond yield rose from 5.1 per cent in January to a high of 6.4 per cent in October while the benchmark German ten year bund yield jumped from 3.65 per cent to 5.45 per cent over the same timeframe. The Irish market fared no better with the yield on long dated Irish bonds rising from 4.3 per cent in January to over 6 per cent in October.

To finish on a positive note, the market recovered some ground in the closing months of the year. Let us hope this is a sign of better things to come in 2000.

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