Friday, December 4, 2009

The Debts of the World: Will High Grade Corporates Eventually Supplant Government Bonds?

Will high grade corporates eventually supplant government bonds?

The once unthinkable state of affairs - that ultra safe government debt commands a lower yield than private capital - might soon be reversed. Deteriorating fiscal conditions in the UK, USA, and other countries (primarily the Eurozone but feel free to throw in other culprits) might lead to a reversal of fortune for governments.

In particular, I have been looking at the Gilt market for UK government debt. It is possible that the authorities may be forced into a corner over the next year when the BOE's bond purchase program ends in January 2010.

However, the government has a potential ace up their sleeve - the imposition of higher regulatory capital among bank balance sheets. The FSA and its sister agencies in the US and the Eurozone have been contemplating lower leverage ratios among insurance companies, banks, and other private sector financial entities. They have hinted that the "safest" form of capital in terms of liquidity are government bonds as opposed to commercial paper. The sudden demand for government paper could flatten yield curves.
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