Judging by 5-year credit default swaps on sovereign debt, it looks like Japan, Germany, the US and France are still the safest bets to park your cash in sovereign debt. It has only been in the last year however, that the US lost its first place status as the least risk country.
Remember CDS prices (in 000’s) represent the price of insurance for $10,000,000 of debt. Thus it currently costs $68,000 to guarantee $10 million of US treasuries. While the G7 still remain the safest issuers of sovereign debt, consider that only a year ago the price to insure $10 million of US debt was only $9,000 dollars. That is a 7.5x increase. Historically that cost was so slim relative to the yield on the treasury it didn’t make sense to add it in. Despite the recent rise in treasury yields, the risk free rate is still abysmally low. Consider that when making investment decisions. Every percent of return above the risk free rate represents a significant unit of associated risk.
Thus, the real risk free rate ought to subtract the cost of protection. Currently the 5-year treasury is yielding 1.846%. Subtract the 0.0068% for the insurance, and the real 5-year risk free rate becomes 1.116%. Of course in a deflationary period the real rate of return is higher, but 1% over five years is going to put a damper on people used to picking up 300 bps of return over treasuries for the commensurate amount of risk. And that fact is going to place a mountain of pressure on public and private pensions, most of which are managed to 8% or higher hurdle rates.
This weekend Barrons reported on private equity as the next ticking timebomb. While I agree, pensions will follow soon after, and countless corporations facing slowing growth and earnings are going to be hit with massive underfunded pension liabilities, liabilities that will need to be funded by paultry earnings. Already in the taxable muni market some pension issues cannot find buyers. Watchout equity holders!
Look for negotiations around changing the rules on 401k plans over the next two years, a lot is going to have to change to keep the baby bommers solvent in their retirement.