Government bond sell indicators flash red

The sovereign debt of the major economies is no longer a safe haven and investors are growing increasingly concerned as the sell indicators flash red.

Swiss & Global’s investment supremo Stefan Angele today warned that the UK and US are now in ‘PIGS’ territory, with the Bank for International Settlement also saying their economies are in just as bad a shape as the Mediterranean countries.

Gavekal economist James Barnes says there is no value in holding government bonds at their present valuations with even the major western economies creaking badly.

Indeed, he points to three sell signals that are making him nervous. Firstly, he highlights deficit fears and the risk of a return to bond vigilantism if there is a debtholders’ rebellion. The Asian central banks’ heavy buying of OECD debt largely rid the markets of bond vigilantes, but if they were to change tack, as a species they could recover, he warns.

‘Up until now, the markets have really only been selling weak European sovereigns, and the bigger economy debt is still thought of as "haven" status,’ Barnes says.

‘But will this vigilantism start to spread up the value chain? After all, in Europe not only the PIIGS, but large countries like France will also need to implement some hefty austerity measures, which at the very least implies further Euro devaluation.’

‘And this time around, we might not have Asian central banks there to pick up the slack.’

Secondly, the pressing need to deleverage in the west will inevitably result in lower growth in the west, which is likely to result in the faster growing East becoming more inward looking, he says.

‘The macro-economic solution for these nations is to switch to more pro-consumption models; this in turn means more flexible currency policies, which ultimately spells lower central bank demand for OECD bonds,’ Barnes notes.

Added to this is the concern that in the event of future liquidity squeezes, the US Federal Reserve will provide more, meaning Treasuries are less attractive as liquidity insurance.

The third indicator is the likelihood that interest rates will be held low for a sustained period making equities GaveKal’s preferred asset class.

‘If this strategy were successfully deployed then we would want to be in equities so as to enjoy a more leveraged return from the rebound in growth,’ Barnes says.