This is just an addendum to what I just wrote about Spain’s difficulties. I have been following the debate about the dearth of safe assets and I believe the idea is intriguing and has merit. Two posts I want to highlight here on this are from Matthew Klein at the Economist and Izabella Kaminska at the Financial Times.
The crux here is that as the financial crisis has reduced the ranks of countries with pristine macro fundamentals, the availability of safe assets has declined precipitously. Meanwhile central banks have lowered interest rates to the point where real yields on government bond assets are at historic lows. This puts investors in a bind where they have funds to invest but a limited number of options, both in terms of yield and in terms of asset quality. The result has been a schizophrenic risk-on risk-off kind of investing environment in which periods of increased risk seeking return mentality alternate with periods of panic flows to perceived safe havens. Despite the all clear that policy makers are now giving on this front, I expect this behavior to continue.
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