Research & Analysis for Business
and Investment Clients
NEW YORK CITY – OCTOBER 2013
The Bank for International Settlements (BIS) is at the epicenter of world markets and international monetary flows. Given this unique view of the world economy, the analyses produced by the BIS provide a macroeconomic glimpse into the near-term financial future for nations and governments.
Monetary Policy Uncertainty
As discussed in the Q3 2013 review, advanced and emerging economies panicked, then rebounded after calm reassurance from central bankers. Markets had been buoyed by global central bank easing (Q2 2013 review), but plummeted on only a hint that Federal Reserve purchases would diminish in coming months.
Uncertainty over United States Federal Reserve rate tightening rippled through developed and emerging markets from late May through July 2013. Bond yields jumped worldwide with emerging market local currencies declining dramatically (Russia, Brazil, and India’s local currencies dropped 10-20% from March to September 2013). The yield on the benchmark 10-year US Treasury jumped 100 basis points (a 58% increase). High-yield emerging market rates were more volatile – jumping 130 basis points.
The trigger occurred on 22 May 2013 when Ben Bernanke, the Federal Reserve Chairman, indicated that the Federal Open Market Committee (FOMC) was considering reducing asset purchases (the Federal Reserve currently adds $85 billion in assets to its balance sheet per month). Precipitous declines followed worldwide. Until the Federal Reserve, BOE, and ECB re-assured market participants that recovery policies would remain accommodative for the foreseeable future, markets demanded higher risk premia, equity indices wilted, and local currencies swooned. Notably, foreign investors reduced long-term United States securities holdings by $78 billion (with $41 billion reduction in US treasuries). Relative to US GDP (0.5%) this value is small but notable.
According to BIS predictions based on Fed funds futures curves, Fed policies will remain at historical lows well into 2014. An aggressive interpretation suggests policies will change around mid-2014. A conservative interpretation suggests policies will tighten by mid-2015. Values are consistent with public information conveyed by the Federal Reserve and Bank of England. The Fed has stated that it aims to guide the economy to 7% unemployment by mid-2014, while the Bank of England estimates that unemployment will be reduced to 7% by 2016.
NOTE: The US Federal Government shutdown is expected to further extend the Feds recovery program duration.
Investor Risk Appetite Increases
With central banks holding rates at 20-year lows, investors holding cash-equivalents and 10-year treasuries expect returns ranging from near zero to 2.5%. With rates at such low values for the last 5 years, investors have sought securities with higher risk premia.
To meet investor demand, banks have seen appreciable increases in subordinated debt (less senior debt carrying higher investor risk but higher yield), contingent convertible capital (CoCos), and leveraged loans. Remarkably, the BIS notes that leveraged loans account for 45% of all new syndicated lending issuances. A value 10% higher than the pre-crisis level. This remarkable level is of obvious concern to the Federal Reserve, which recently issued a warning on lax leveraged loans underwriting