Amid elevated market uncertainty, investors have been clamoring to get their hands on so-called “safe assets,” privately and publicly issued securities with little risk used to hedge against more volatile investments.
Of primary focus has been sovereign bonds. U.S. government Treasuries, Japanese government bonds, and German bunds are trading at record highs, yielding little profit for investors.
But the scarcity—and thus the high price of these securities—has been exacerbated by central bank measures taken to mend the troubles of the crisis.
Since the financial crisis, quantitative easing has essentially given banks in the U.S. and U.K fast cash in exchange for Treasuries and gilts, and immediately freed up funds to put money in riskier places that would spur corporate growth.
However now investors are worried that the long-term effects of driving up the cost of safe assets will make it harder for institutional investors like investment banks and hedge funds to meet the stricter standards of new rules put in place to ensure financial stability.
PIMCO’s Mohamed El-Erian expressed this anxiety in a speech to the Federal Reserve Bank of St. Louis yesterday. “In the last three plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability,” he said. “In the case of three institutions in particular (the Bank of England, the Bank of Japan and the Fed), they also change the balance between “safe” and other assets in the financial system.”
The International Monetary Fund has seconded this concern. A team of IMF economists led by Silvia Iorgova describe the crux of this problem in a report out this week (pdf):
The shrinking set of assets perceived as safe, now limited to mostly high-quality sovereign debt, coupled with growing demand, can have negative implications for global financial stability. It will increase the price of safety and compel investors to move down the safety scale as they scramble to obtain scarce assets. Safe asset scarcity could lead to more short-term volatility jumps, herding behavior, and runs on sovereign debt.
Essentially, because there are fewer safe assets, investors are forced to move to riskier assets less agile at hedging their bets if they want to invest at all.
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- Counterparties: ‘Bridges to nowhere’ in central banking (blogs.reuters.com)
- Safe keeping (economist.com)
- Bill Gross: “The Game As We All Have Known It Appears To Be Over” (zerohedge.com)