Tuesday, June 26, 2007

The Short View: Flight to quality

The Short View: Flight to quality
By John Authers, Investment Editor
Copyright The Financial Times Limited 2007
Published: June 25 2007 17:34 | Last updated: June 25 2007 17:34

When will world markets fly to quality? Typically, periods when investors buy into relatively risky assets - and we are in such a period now - are followed by a rush back into safe havens such as treasury bonds.

But investors in risky assets are staying put. After Friday’s Wall Street sell-off, Monday started in “flight to quality” mode - sale of Chinese equities, a bad day for European bourses, buying of US bonds, and a recovery for the yen, which had hit its lowest level in more than a decade.

But US housing data stemmed the flow. They showed existing home sales falling by less than many had expected, while the overhang of unsold houses increased. This was no reason to call an end for the problems of the US housing market, but it was enough to call off the flight to quality. Stocks recovered, and bond yields rose once more.

It is still hard to doubt the need for a flight to quality.

Take emerging markets bonds. Many emerging jurisdictions are now getting their economic house in order, but the repricing of their debt is impossible to explain without invoking the world’s big flows of liquidity.

Since 1999, the JPMorgan EMBI composite index has shown the spread payable on emerging market bonds compared to treasuries dropping from 14 percentage points to 1.56 percentage points today.

But this still does not make clear the extent of the market’s confidence about risk.

Angela Montero, of Société Générale, pointed out last week that Mexican bonds yielded 5.85 per cent. 10-year bonds in Colombia, gripped by scandal and guerrilla war, yield 6 per cent. US treasuries yield only about 5.15 per cent, but, more tellingly, New Zealand and Australian bonds yield 6.2 and 6.75 per cent respectively.

This is in local currency terms, and speculators have pushed the aussie and kiwi dollars to excessive levels. But can Mexico or Colombia really be a safer bet to repay a loan than Australia or New Zealand?


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