Government bonds losing their risk-free status are depriving investors of wealth-preservation opportunities as Europe’s debt crisis boosts demand for havens, according to the Bank for International Settlements.
The global pool of safer assets “has shrunk just as demand has risen due to a flight to safety, leading to a major shortage of safe assets in the global financial system,” the BIS said in its annual report published yesterday in Basel, Switzerland. “The deterioration in the perceived creditworthiness of a sovereign raises the funding costs of virtually all private borrowers in its jurisdiction.”
While Europe’s leaders are struggling to end a crisis that threatens the euro, a drop in investor confidence has left Germany as the only nation with a stable outlook on its AAA rating among the currency’s 17 members. Its borrowing costs are near record lows as investors seek refuge from a financial turmoil now in its third year and which has pushed Spain’s 10-year yields above the 7 percent level that forced Greece, Portugal and Ireland to seek international bailouts.
States “whose debt is risky cannot provide a reliable backstop for the financial system,” posing a danger to financial stability, the BIS said. That also means that risk-averse investors are “deprived of a valuable and stabilizing wealth-preservation option at times of stress, including in the form of collateral,” it said.
Investors searching for safety pushed the Swiss franc and yen higher, prompting Japan to sell its currency and Switzerland to impose a currency cap as the nation’s government sought to protect exporters. Japan boosted its foreign currency reserves by $185 billion last year while the Swiss National Bank’s reserves surged 25 percent in May compared with the previous month, the BIS said.
The yen strengthened to 76.03 yen against the dollar on Feb. 1, the strongest level since reaching a post-World War II high in October. Switzerland imposed a cap after gains that pushed the franc to 1.0080 per euro on Aug. 9. Treasury 10-year yields slipped to a record-low 1.44 percent on June 1.
Demand for U.S. debt has grown even as the Treasury Department boosted the amount of outstanding marketable debt to more than $10 trillion from $4.34 trillion in mid-2007, sustained by a lack of safe alternatives.
“Sovereigns have been losing their risk-free status at an alarming rate,” the BIS said. “Restoring sustainable fiscal positions will require implementing effective fiscal consolidation, promoting long-term growth, and breaking the adverse feedback loop between bank and sovereign risk.”
The BIS holds currency reserves on behalf of its members and provides policy makers with a forum for discussion.