Continued Record Low Rates Spur Markets, According to BIS
From early September to late November, a steady stream of mostly positive macroeconomic news reassured investors that the global economy had in fact turned around, but investor confidence remained fragile, according to the Bank for International Settlements (BIS). The BIS Quarterly Review: International Banking and Financial Market Developments reported that this was clearly illustrated towards the end of the period under review, when prices of risky assets dropped sharply as investors reacted nervously to news that government-owned Dubai World had asked for a delay in some payments on its debt.
Market participants expected the recovery to continue, but at times grew wary about its pace and shape due to uncertainty about the timing and speed of withdrawal of monetary and fiscal stimulus as well as the associated risks to economic activity. The unease was compounded by the unevenness of the recovery among different regions of the world, which in turn was seen as increasing the risk that harmful imbalances could build, thereby adding to challenges for policymakers.
In this environment, market developments continued to be driven to a significant degree by ongoing and expected policy stimulus, in particular expansionary monetary policy. As investors priced in expectations that interest rates in major advanced economies would remain low, prices of risky assets continued to increase. Equity prices generally rose, in particular in emerging markets.
Investment grade credit spreads were little changed, while sub-investment grade spreads narrowed further. Expectations of a prolonged period of low policy rates kept long-term government bond yields down, as did low term premia. Some market commentary pointed to the risk of higher inflation going forward, but both market- and survey-based indicators continued to suggest that price pressures in the largest advanced economies were expected to remain well contained.
The low interest rates in the advanced economies, together with the earlier and stronger recovery in a number of emerging economies, continued to drive significant capital inflows into emerging markets, particularly in Asia-Pacific. Although difficult to quantify, a related development was increasing foreign exchange (FX) carry trade activity funded in US dollars and other low interest rate currencies. This resulted in rapid asset price increases in several emerging economies as well as substantial exchange rate appreciation with respect to the US dollar.
Highlights from the BIS Statistics
Banks’ international balance sheets continued to contract during the second quarter of 2009, albeit at a much slower pace than in the preceding six months.
The US$477bn decline in the total gross international claims of BIS reporting banks was considerably smaller than the reductions registered in the prior two quarters, but was still the fourth largest in the last decade. The shrinkage in international balance sheets was entirely driven by a contraction in interbank claims, which fell by US$481bn. By contrast, international claims on non-banks increased slightly (by US$4bn). Reporting banks’ cross-border claims on emerging market borrowers also showed signs of stabilising. Conversely, their local positions in local currencies in many countries contracted modestly for the first time since the onset of the crisis.
In the first half of 2009, notional amounts of all types of over-the-counter (OTC) derivatives contracts rebounded somewhat to stand at US$605 trillion at the end of June, 10% higher than six months before. In contrast, gross credit exposures fell by 18% from an end-2008 peak to US$3.7 trillion. Gross credit exposures take into account bilateral netting agreements but not collateral, so they provide a measure of counterparty exposures. The increase in outstanding amounts was due in large part to interest rate derivatives. By contrast, continuing a trend that began in the first half of 2008, outstanding notional amounts of credit default swap (CDS) contracts fell to US$36 trillion at the end of June 2009.
Activity on the international derivatives exchanges stabilised at around 60% of the pre-crisis level in the third quarter of 2009. Total turnover based on notional amounts was unchanged from the previous quarter, at US$425 trillion.
Seasonal factors weighed on activity in the primary market for international debt securities in the third quarter of 2009. Net issuance almost halved to US$475bn, the lowest level since the third quarter of 2008. Depending on the method used, seasonally adjusted issuance either remained stable at a high level or went up slightly. The decline in activity was mainly driven by lower net issuance by borrowers resident in developed economies (-45%), which account for the bulk of borrowing on the international debt securities market. Residents in emerging market economies took advantage of the improved financing conditions and issued US$34bn of international debt securities. This was 52% more than in the second quarter and well above the quarterly average for 2006 and early 2007, prior to the crisis.