Why governments have financial interest in higher inflation

June 21, 2014

With G7 public debt stocks at record highs, inflation has become a key fiscal concern. A new IMF paper estimates that a fall of inflation to zero would raise debt ratios by another 5-6%-points. A rise of inflation to 6% would lower debt ratios by 11-18%-points of GDP through real debt erosion. Inflation would offer additional fiscal benefits, such as higher revenues through “seigniorage” and progressive income tax tariffs.

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How human stress increases financial crisis risk

June 15, 2014

John Coates gives a neuroscience view on how human “stress response” can aggravate financial crises. Rising market volatility causes a bodily response in form of a sustained elevation of the stress hormone cortisol in traders and investors. This raises risk aversion and may contribute to institutional paralysis. Central banks’ policies aimed at keeping markets calm in normal times may weaken traders’ immune system.

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How statistical risk models increase financial crisis risk

June 14, 2014

Regulators and financial institutions rely on statistical models to assess market risk. Alas, a new Federal Reserve paper shows that risk models are prone to creating confusion when they are needed most: in financial crises. Acceptable performance and convergence of risk models in normal times can lull the financial system into a false sense of reliability that transforms into model divergence and disarray when troubles arise.

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The unintended consequences of leverage ratio requirements for banks

June 8, 2014

The Basel III capital regulation reforms introduced a non-risk based leverage ratio for banks. A new ECB paper shows that a leverage ratio requirement may have unintended negative consequences. It encourages banks that specialize on low-risk lending to raise their share of high-risk loans. And it could make overall bank portfolios more similar, increasing the contamination risk from negative surprises to expected default risks.

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Understanding the ECB’s latest tool: TLTROs

June 7, 2014

On 5 June 2014 the European Central Bank announced Targeted Long-Term Repo Operations (TLTROs]. Their main purpose is to stimulate bank lending to non-financial corporations. The operations would offer conditional cheap funding to banks in large size and for maturities of up to four years. Private loan conditions should ease in response, particularly in the euro area periphery, but the impact on area-wide credit is uncertain. Also, TLTROs might effectively be used for government bond carry trades.

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On public debt and economic growth

June 1, 2014

The view that high public debt is bad for growth, popularized by Reinhart and Rogoff, has failed to find much empirical support in academic research. A paper by Lof and Malinen presents evidence that over the past 55 years lower growth has typically preceded higher debt but higher debt has not usually preceded lower growth.

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The idea of uncovered equity parity

May 31, 2014

Uncovered equity parity explains how equity portfolio rebalancing affects exchange rates. Outperformance of foreign stock markets, whether through the exchange rate or stock prices, leaves investors with excess exchange rate exposure. The reduction of this exposure then puts depreciation pressure on the foreign currency. A new Federal Reserve paper presents evidence for the essential parts of that theory.

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The Federal Reserve’s strategy after tapering

May 25, 2014

William Dudley provided an update of the Fed’s strategy for normalizing monetary policy. Under appropriate economic conditions, policy rates could begin rising in 2015, a considerable time after open-ended asset purchases have ceased. Rates increases would be tempered by tightening financial conditions and are seen to converge on a level below 4%. Discretionary balance sheet reduction should follow, not precede, rates normalization. Large excess reserves are not expected to compromise control over short-term interest rates.

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Why bond yield compression cannot easily be reversed

May 24, 2014

Non-conventional monetary policy has inflated central banks’ balance sheets and compressed long-term yields. A new BIS paper makes some points on why reversing this portfolio effect is problematic. The financial system has much greater exposure to government bond yield risk than in the past. Spillover risks for private debt and emerging markets are elevated. And conflicts may arise between central bank and public debt management policies, increasing uncertainty for markets.

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How equity return expectations contribute to bubbles

May 18, 2014

An updated paper by Adam, Beutel, and Marcet claims that booms and busts in U.S. stock prices can be explained by investors’ subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market troughs.

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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.

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