Goodbye to the risk-free rate | FT Alphaville

Goodbye to the risk-free rate

Morgan Stanley’s Graham Secker has put out an interesting note on the rising cost of capital on Monday.

And it’s not a cheery read if you happen to be a sovereign issuer, given the shift of private-sector debt into the public sector.

According to the MOST analysts, the most important macro theme for the next few years will likely be the ease (or difficulty) at which sovereigns pay down the deficits they’ve incurred during the course of the financial crisis.

Greece, unfortunately in that case, may only be a taster of what’s to come. As the analysts note:

Greece may well prove to be a taste of things to come, in our view. However, the speed and extent of any contagion are hard to predict . We think that the 50-year+ low in government bond yields (real and nominal) seen in this cycle will not been seen again for many years to come. In effect, the size of the public debt burden means that the ‘risk-free rate’ has become more risky.

And here’s a rather enlightening chart produced by the bank to illustrate which countries are likely to come under more pressure than others in this regard:

Collectively in Europe, Morgan Stanley notes EU banks have something in the region of $1,000bn in debt to rollover in the next two years. Due to the contagion factor from Greece, this will have to take place at a much higher cost of capital.

In the irony of the day, however, the analysts forecast it will be the banks that have substantial scope to buy much of that government paper.

Not that they won’t be inclined to charge for it (emphasis FT Alphaville’s):

Many investors look to the banks as a natural source of demand for sovereign debt going forward, but we think this is likely to come at a cost in terms of less credit availability in the wider economy and lower ROEs for the banks themselves.

A fact that Morgan Stanley’s analysts say — irrespective of where rates go — will lead to a higher cost of capital for all.

To recap: That would be banks over-charging sovereigns for the debt they incurred by rescuing the banks.

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– FT Alphaville
On the matter of sovereign spreads widening – FT Alphaville