Montreal, Canada

About a year ago in this column I had forecast a gradual shift from the markets' perception of safety as it pertains to government bonds. The way I see it, some countries don't deserve their coveted AAA credit rating while high quality corporate bonds (outside of the financial sector) should command a lower risk premium because of their bullish balance sheet fundamentals.

Though corporations can't print money and governments can, the market is starting to apportion a higher risk premium to deficits and the possibility of a sovereign default. The odds this will happen to the weakest countries are increasingly likely amid Year III of the credit crisis.

Some of the most ridiculous credit ratings include awarding the United States a AAA rating in the face of never-ending monster-sized deficits. Other countries, like the United Kingdom, don't deserve a AAA rating, either. The rating agencies are corrupt and are probably paid-off by the governments they rank. The only countries that deserve a AAA rating are Norway, Switzerland and, possibly, Germany, Australia and Canada. That's about it.

Markets are growing nervous. Risk premiums on British, Spanish, Irish and, especially, Greek government bonds have increased much higher than corporate debt spreads recently. If this trend continues and leads to a bond market crash or a series of weaker sovereign defaults then global stocks will fall very hard.

And the best time to buy stocks is after a country's currency or debt market collapses. I'll leave that discussion for another time but refer to British and Italian stocks in the aftermath of the 1992 ERM (European Exchange Rate Mechanism) debacle. Twelve months after leaving the ERM grid stocks in both countries went through the roof as they gained a big export edge over their European rivals. Devaluations are dreadful for bonds but amazing for equities.

Though government bonds have historically provided safety and were regarded as the highest quality along the fixed-income curve, the credit crisis has changed risk premiums. The massive weight of bulging government fiscal deficits continues to put pressure on risk premiums and, in some countries, has completely altered the way investors interpret credit risk.

In Europe, for example, Germany is considered the risk-free benchmark for bonds. Benchmark ten-year Greek government bonds now fetch 236 basis points more than comparable German bunds. At some point, I continue to believe Greece will leave the single currency and eject itself from European Monetary Union (EMU), similar to England and Italy in September 1992. The Greeks have too much pressure to cut debt and any serious deficit spending reduction will result in outright deflation. The best course for Greece is to leave EMU and reintroduce the Greek drachma.

The corporate bond world is also fetching a higher bid compared to some government bonds.

In the United Kingdom, benchmark British government bonds, or gilts, trade at a higher risk premium to many high quality bonds in the same country. British Petroleum plc, which has more cash in its coffers than many frontier emerging market central banks, sells at a lower risk premium based on its credit default swap rates than comparable British gilts. It's the same story for Unilever, BAE Systems and Cadbury, to name just a few high quality names.

In the United States, the largest deficit country in the world in absolute terms, corporate bond spreads trade 45 basis points, or 0.45%, above ten-year Treasury bonds. That's slightly ahead of their historical range and certainly much lower compared to 12 months ago, when yields traded north of 8% when credit markets exploded.

But in all reality, if the U.S. wasn't a reserve currency and didn't print its own money, I'm pretty sure high quality corporate paper like IBM, General Mills and Procter & Gamble would yield less, not more, than T-bonds. High quality non-financial companies can't print money but they also don't have credit problems or huge outstanding deficits.

In 2010 it is very likely that one or several sovereign borrowers will default. The first dominos to fall are those with the highest outstanding debt-to-GDP ratios in the peripheral advanced and emerging market economies. This includes Eastern and Central Europe and, possibly, one or more countries in Latin America.

The International Monetary Fund (IMF) will be busy this year and into 2011 as it begins another round of sovereign bailouts. Count on it.