John Plender writes in yesterday’s FT that the pool of “super safe assets” is shrinking, whilst legal and advisory firms around the world scramble to prepare their clients for the implications of new currencies (or should I say old currencies returning in new guises).

Mr Plender considers whether “investment performance this year will hinge even more than in 2011 on making the right judgement on the evolution of Europe’s sovereign debt crisis… where a weak banking sector undermines the sovereign sector and vice versa”.

We are told that whilst the emerging markets have failed to perform as a haven, with the MSCI Emerging Markets Index falling 20.6% last year, only the highest quality bonds can be considered as insurance against the potential storm.

Searching for safety

The problem is that the range of depth of these potential high quality bond markets is shrinking.

The non-financial sector is sitting on huge cash piles, but not issuing much debt to fund investment. Good quality corporate debt is not as available as institutional investors would like, and certainly not with the depth of market they require. Mr Plender informs us, “global triple-A rated corporate issuance was down to $218bn in 2011 compared with $450bn in 2006”. Within this total, “US companies issued only $9bn compared with $140bn in 2006”.

All the while the apparent huddle of sovereign borrowers investors can bank on is being eroded by these financial tides; rather like the sea lapping at a group of sand castles. The debt pressures in Europe are still the proverbial tinder box within the global financial system, although other highly indebted entities, states, and municipalities might be enjoying a temporary respite from Mr Market’s revealing spotlight.

Whilst the UK gilt market and US treasury market are suggested for capital searching for a safe home, negative real yields abound. Things are still bad enough that many investors are willing to pay nations such as Germany to borrow from them, although Mr Plender urges that even Bunds cannot be regarded as safe.

The US treasury market is also not currently as liquid as global investors need, with the Federal Reserve buying so many treasuries itself as part of QE (are we QE2, 3, or ‘constant’ now?).

The problem is that market participants “are demanding more and higher quality collateral, which leads to further shrinkage in the pool of safe assets”. This is occurring as Merkozy’s…

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