Global economy creating an imbalance in asset classes

There are strong signs that global economic activities are picking up nicely. The pick-up in economic growth is spreading widely and evenly. Starting from the biggest economy in the world, US economy is still growing albite not accelerating but still growing and helping pull the rest of the world with it. However, there is a great concern among investors not about the actual global economic growth but about where to invest safely. The problem is to find a new asset class that is safe and gives good return for global investors. There is an imbalance in all asset classes regardless which economy to look at.

Some nations keep accumulating wealth and saving such as Japan and China and Germany but their economies and capital markets lack the sophistication to create local risk free instruments for at least their own savers. As for professional investors, there are diversified investments assets that they can tap into when it is needed. For those economies and some other rich nations, the reliance on the most developed economies to offer them different asset classes continues and this is where the risk to the global economy can happen.

Here I am talking about increase in volatility either in the foreign Exchange, fixed income or the commodity markets. Most of the world’s savings and wealth are still parked in the US Treasury market. This can easily be explained by just looking the US yield curve and the very low yield on long term US Treasury. US treasury is the safest asset class in the world but investors can’t avoid volatility when the global economy still not synchronized.

Savings glut

The world economy is still facing a savings glut that refuses to go away. This is simply savings that are eating away from accelerating global economic growth and job creations for those nations that faces saving glut. One of the consequences of this is the record low of yield on most developed government bonds even as the Federal Reserve hikes interest rates.

These days, current account imbalances among the US, China and Japan have come down, and Asia’s biggest economies are carrying higher debt loads, undermining the idea that there’s too much savings. Instead, the problem is that emerging economies haven’t yet been able to develop assets that investors are willing to hold as stores of value and collateral when times get tough. Doing that requires strong levels of confidence in the rule of law, equitable regulation and belief that money can be withdrawn by the investor whenever needed.

This problem not only apply to the emerging markets but some others that have huge savings and wealth such as Japan, China and Germany. They still do not have a sophisticated and diversified capital markets that match the real sectors that reflect their economies. The imbalance of a growing economy and underdeveloped capital market, make their savers and investors target the safe-haven assets such as the US Treasuries, German bunds, and the British gilts. These fixed income assets are becoming increasingly rare and in short supply. Obviously offering those savers miserable low yields.

Overseas investors

Purchases by central banks in the developed economies of their own government bonds have made the situation worse for overseas investors. It also made the supply of such government bonds limited. The Federal Reserve is trying to unwind this unusual situation by normalizing its interest rates by raising rates with its attention on plans to dial back its $4.5 trillion balance sheet.

China, as the world’s second-largest economy, offers the best gamble to develop a substitute to the US Treasuries market, though its capital controls have left foreign investors wary to take full advantage of new avenues to invest in its government bonds. China’s unpredictable and volatile foreign policy against its neighbors and the US, discourages its domestic and foreign investors to accept Chinese assets haven at least for now. Very strong and dynamic demands have also contributed to the shortage of haven assets. International investors are scared to purchase what was perceived to be haven government bonds in some developed economies that turned out to be less than safe in the global crises. Investing in a world with a more subdued growth path since, investors have piled into assets seen as low risk such as US treasury, Japanese government and German bonds.

China can create an alternative to US Treasury but that is if the Chinese government is serious and able to do so. That will take a long time. The European central bank is giving and encouraging the Chinese government to do so by shifting a small portion of its dollar reserves into the Chinese Yuan. But that’s one drop in an ocean of official holdings that’s on the rise again. In the meantime, international investors and savers are still chasing haven assets and the worry about the unusual configuration of asset prices and their volatility and reaction to shocks or any bad news goes on.