London - The universe for safe haven assets is shrinking
fast.
A selloff in German government bonds after a weak auction, a
warning on France's triple-A rating and rising risks on US credit after the
collapse of deficit talks spell trouble for investors looking to find a safe
harbour to protect their capital from the escalating eurozone crisis.
They had already turned their focus away from gold - coming
under pressure as hedge funds were forced to sell to meet redemptions - and the
Swiss franc after an exchange rate control imposed in September to stop the
traditional safe haven currency from appreciating.
"There has been a lot of talk about what a safe haven
is. What's interesting is you have crowded trades in safe havens just as we
have crowded trades in other asset classes. Safe haven isn't necessarily a
low-volatility investment," said David Miller, partner at Cheviot Asset
Management.
Political and debt market events in the coming week are
likely to test that premise further.
"Safety is diversification. There is no one answer to
those who want safety. If you have a balance of different assets, you build in
a margin of safety," Miller said.
He said an example would be holding a selected number of
government bonds in the United States and Britain along with companies with
sound balance sheets paying good dividends.
The selloff in German bonds highlights the danger of putting
all your eggs in one basket.
"As a result of Bunds increasingly losing their safe
haven status the euro is increasingly affected by the crisis, as it means that
no euro-denominated safe haven is available," Commerzbank said in a note
to clients.
"In 2008/2009 Bunds were one of the three forms of
investment which remained stable and liquid during the pronounced crisis.
Anyone expecting that to be the case again so far did not have to reduce their
EUR positions despite the crisis. This point of view will have to be
reconsidered though."
Safety and yields
US President Barack Obama, European Council president Herman
van Rompuy and European Commission president Jose Manuel Barroso meet on Monday
in Washington, where Europe's response to the two-year crisis is expected to
top the agenda.
Also in the coming week, France, Britain, the United States
as well as Italy, Belgium and Spain are holding debt sales, with concerns over
the appetite for triple-A paper a key issue after the disappointing German
auction on Wednesday.
Berlin's debt agency failed to find buyers for almost half a
bond sale of €6bn, pushing Germany's borrowing costs over 10 years above those
of the United States for the first time since October.
Even as world stocks slid to seven-week lows on Friday,
German government bonds failed to attract safe haven flows.
The underperformance of Bunds in the past week has left them
yielding almost the same as UK 10-year gilts and around 20 basis points more
than US Treasuries.
But gilts are not without risks, with UK economic growth
stagnating and the unemployment rate at a 15-year high of 8.3%.
UK finance minister George Osborne delivers a budget
statement on November 29 to parliament including new forecasts for growth,
inflation and public finances.
Aside from the safe haven allure, investors are increasingly
being put off by the negative real yields that such paper offers.
German, US and UK 10-year real yields - benchmark government
bond yields minus consumer prices inflation rate - are in negative territory,
with Japan boasting the highest real yield among the four of about 1%.
Even on a nominal yields basis, Switzerland already offers
negative yields - meaning that investors must pay for the privilege of parking
cash in safer markets. Singapore also experienced negative rates earlier this
year.
EuroSwiss interest rate futures currently imply a negative
rate lasting until as late as June 2013.
And with the escalating tensions in the funding market -
with the cost of swapping euros for dollars hitting a three-year high - the
contagion effect is moving to the top of investors' worry list.
"Investors shouldn't forget that the reluctance of
banks to lend to each other because of their holding of sovereign debt is now
imposing a tightening squeeze on banks themselves. That's what caused a problem
after the Lehman bankruptcy.
"We're starting to see signs of that developing in
Europe," said John Greenwood, chief economist at Invesco Limited.
"The eurozone crisis will rumble on and we will have a
risk-on and risk-off and it's very difficult to focus on a single
strategy."