The IMF Financial Stability Report highlights two systemic weaknesses of plain-vanilla mutual funds: incentives for end investors to rush for the exit in distress and incentives for portfolio managers to herd. With deteriorating market liquidity and greater systemic importance of collateral values, these weaknesses become a greater concern for the global financial system.
The latest IMF fiscal monitor underscores three key fiscal trends. First, deficits in the developed world keep narrowing, thanks to past fiscal tightening and present economic growth Second, public debt ratios remain high and are unlikely to fall back below 100% of GDP this decade. Third, emerging markets fiscal numbers are deteriorating.
The variance risk premium is paid by risk-averse investors to hedge against variations in future realized volatility. Empirical evidence and intuition suggest that equity markets indeed pay over the odds for downside risk in mark-to-market variations but accept a discount for upside risk. The highest premium is paid for downside skewness risk. These forms of variance risk premia have been significant predictors of U.S. equity returns.
The importance of collateralized transactions for the global financial system has greatly increased since the financial crisis. Moreover, the influence of central banks on supply and pledgeability of collateral has become more pervasive and explicit. Investment managers must calculate with the impact of central bank policy and operating frameworks on financial conditions via this “collateral channel”.
A new BIS paper summarizes motives and impact of FX interventions. Most importantly it looks at the conditions under which such interventions are effective (and hence likely). The strongest case for interventions arises when [i] the central bank has a clear view about an exchange rate misalignment, and [ii] the intervention would not go against the interest rate differential.
A Chicago Fed paper argues that economic uncertainty at the zero lower bound (ZLB) should be a cause of looser monetary policy. This is basic risk management, as confirmed by Fed Chair Janet Yellen. Near the ZLB unduly tight monetary policy is more difficult to correct than unduly easy policy. Moreover, the mere risk of being constrained by the ZLB tomorrow affects expectations already today and can reinforce the severity of the ZLB constraint.
An empirical study shows that U.S. mutual funds take two major allocation decisions: bonds versus equity and U.S. versus non-U.S. assets. Federal Reserve policy easing encourages shifts into foreign assets. High uncertainty drives allocations out of risky assets into U.S. treasuries. And the relative performance of foreign versus U.S. assets leads a chase of the higher return. Within fixed income institutions tend to reallocate gradually towards higher prior yields.
A Bank of England paper integrates commodity futures with bond yield curves. It finds that bond factors exert significant influence on commodities. It also finds that risk premia paid in crude oil futures have shifted over the decades from negative to positive, as crude’s hedge value faded with the memory of the oil crises. Gold futures have long paid a positive risk premium for lack of empirical hedge value.
China’s economy has long relied on compressed interest rates in conjunction with strict capital controls and a tightly managed exchange rate. A new ADBI paper suggests, however, that modest liberalization and gradual internationalization of the renminbi since 2005 have lessened state control over financial parameters. Inconsistencies and risks of market dislocations have become more evident.
A new IJCB article shows that historically [i] inflation expectations had a strong impact on long-term yields and [ii] economic data surprises had a strong impact on inflation expectations. However, the influence of compensation for inflation and inflation risk on U.S. bond yields has faded in the era of non-conventional monetary policy.
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.
