Emerging market exchange rates can be catalysts of self-reinforcing trends. Currency appreciation raises both global lenders’ risk limits and EM institutions’ debt servicing capacity. Currency depreciation spurs the reverse dynamics. Their escalatory potential constrains central banks’ tolerance for exchange rate flexibility.
China consumes about one third of the world’s commodities. However, its influence on commodity prices goes beyond that. Chinese institutions are also major users of commodities as collateral. Empirical evidence shows a significant link between domestic lending and global commodity prices, particularly through so-called commodity financing deals.
Empirical evidence shows that non-conventional monetary policy in large advanced economies has shaped financial conditions in the rest of the world. In particular, non-conventional easing has boosted EM bank balance sheets and securities issuance. This goes some way in explaining why the emerging world has become so vulnerable to even just tapering of these policies.
The expansion of central clearing has created a greater interconnectedness of financial markets and new systemic risks. Large losses of some of clearing members might exhaust central counterparties’ liquid assets and backup lines, triggering unfunded liquidity arrangements and strains on the remaining clearing members. Moreover, collateral requirements of central counterparties could surge in crises.
A DNB paper warns that financial market risk models (such as value-at-risk or expected shortfall) are unreliable. Small variations in assumptions cause large differences in risk forecasts. At commonly used small samples of data forecasts are close to random noise. It would take half a century of daily data for estimates to reach their theoretical asymptotic properties.
China’s financial distortions are rooted in deposit rate controls and implicit loan guarantees. Low remuneration on bank deposits in conjunction with capital controls have long subsidized banks and borrowers. Loan guarantees have spurred excessive lending and neglect of profitability. Reform is perilous as slowing credit would itself undermine credit quality. An IMF model analysis suggests that a removal of loan guarantees would reduce the capital intensity of the economy.
A new Bank of England paper finds a 450 bps decline in global equilibrium real interest rates over the past 35 years, due to a fundamental divergence: savings preferences surged on demographics, inequality and EM reserve accumulation, while investment spending was held back by cheapening capital goods and declining government activity. More recently, fear of secular stagnation has compounded the real rate compression.
The rising importance of high-quality collateral for financial transactions brings new systemic risks, such as potential collateral shortages and secured funding constraints in crisis times. Vulnerabilities are augmented by collateral optimization, transformation, re-use and re-hypothecation. Collateral policy has become an important part of central banks’ toolkit.
If investment funds maximize assets-under-management and end-investors allocate to outperforming funds, the investment process is compromised. A new theoretical paper suggests that asset managers may prefer portfolios with steady payouts (or steady expected mark-to-market gains) and neglect risks of rare large drawdowns, potentially leading to complete failure of parts of the options market.
An empirical study suggests that momentum trades yield positive returns but carry higher downside than upside market risk. This “beta asymmetry” appears to be a global phenomenon across asset classes. It is consistent with the broader observation that popular trading strategies come at the price of setback risk related to the crowdedness of positions.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
