Forex Flash: Structural liquidity preference for AAA remains strong – UBS

If we look beyond the short-term, structural liquidity preference for 'super AAAs' remains very strong. As such, “marginal allocations by reserve managers and other funds with 'risk averse' mandates' within this group will rise on a nominal basis. To satisfy such demand, it appears that such countries have actually started to increase their issuance; if anything it helps avoid volatility in their own sovereign bond markets.” suggests Research Analyst Gareth Berry at UBS.

Even excluding Finland's recent addition to the 'super AAA' bloc, some countries in the original group has increased their outstanding debt levels. The dollar's recent decline has also increased aggregate liquidity, especially from the perception of dollar-based sovereign managers. All of these developments will undermine countries whose ratings view is on the slide (US, UK) rather than the opposite.

Ultimately, perhaps one supportive element for gilts and UK assets is that global standards for safety or AAA have fallen quite significantly. Even the Federal Reserve is starting to worry about reducing liquidity in this due to its own large-scale asset purchases, though for now their activities do not appear large enough in scope to matter. Similarly, the BoE will probably need to look at this issue, given their ownership of gilts is even larger. On the other hand, if investors do believe in the central bank put, then it doesn't really matter who is or isn't AAA.