Deflation continuing in financial market

Dollar Scarce As Top-Quality Assets Shrink 42%

International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The U.S. is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category, data compiled by Bloomberg show.

“The pool of high-rated assets has been shrinking, not just in the euro zone but elsewhere as well,” Ian Stannard, Morgan Stanley’s head of Europe currency strategy, said in a May 22 telephone interview. “With the core of Europe shrinking, and the available assets for reserve purposes shrinking, it makes the euro zone less attractive.”

This becomes a self-fulfilling trend as weakening foreign currencies exacerbate the financial position of indebted countries, because the U.S. dollar served as a funding currency during the 2000s. People borrowed (shorted) U.S. dollars and bought up European and emerging market debt. Now, the reverse is taking place, but many foreign assets are also losing their investment status. Those who believe the Treasury bubble is over have much longer to wait because the lack of quality assets will mean a continued strong bid for Treasuries. It also shows that for the time being, gold has plateaued and is not ready to breakout, at least against the dollar. I would still own gold here, because things can change in an instant, but odds favor continued deflation and weak gold until the U.S. becomes the focus of market attention—possibly in late summer or early autumn.