Unconventional monetary policy: impact and exit problems

October 15, 2013

According to a new IMF report, unconventional monetary policies succeeded in stabilizing financial markets and lowering sovereign yields. Since protracted accommodation would invite excessive duration risk taking, the design of exit is becoming more important. Tightening may occur first through forward guidance or even rate hikes, before the vast outstanding excess reserves can be reduced back towards pre-crisis levels. This could imply greater volatility of interest rates, due to limited control of central banks over short rates and great uncertainty about the impact of tapered and reversed purchase programs on long–term yields.

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The world’s fiscal outlook

October 11, 2013

The IMF projects that 2013 will see a big reduction in the developed world’s fiscal deficit by roughly 1.5%-points to 4.5% of GDP. By now the majority of highly-indebt countries seems to have achieved about two-thirds of the required post-crisis fiscal consolidation. The advanced countries’ public debt stock remains elevated at 109% of GDP, however, leaving the world vulnerable to higher interest rates and sovereign solvency risks.

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The rising global savings glut

October 9, 2013

A DB paper suggests that the rising median age of the world’s population will increase savings ratios. The trend is reinforced by macro policies aimed at generating external surpluses or at least restraining deficits. The onus of absorbing the resulting savings glut may fall on the United States, which issues the world’s anchor currency. Irrespective of whether it accepts that role, cost of capital for the world as a whole is likely to be compressed by the savings glut.

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Side effects of capital regulation reform

October 5, 2013

Capital regulation reform could lead to excessive bank asset encumbrance and distortions in funding markets, as unsecured institutional creditors face an increased risk of statutory bail-in. Excessive asset encumbrance could undermine a bank’s resolution in distress. Rising costs of unsecured bank debt could lower its share below what is required for loss absorption.

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The U.S. Fed’s new tools to control short-term rates

October 3, 2013

A Federal Reserve paper describes and evaluates monetary policy tools for managing short-term market rates in an environment of large-scale excess reserve money in the financial system. These tools are interest on excess reserves (IOER), reverse repurchase agreements (RRPs) with a wide range of market participants, and the term deposit facility (TDF).

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The case for monitoring shadow banking risks

October 1, 2013

Another Federal Reserve paper on shadow banking emphasizes its systemic risks. In particular, shadow banking seems to have a tendency to accumulate tail risks, relies on fragile funding conditions (without official backstop), and is subject to pronounced pro-cyclicality. Shadow banking activity is tied to core regulated institutions and, hence, is a valid concern for broad financial stability.

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The systemic risk of China’s local government debt

September 28, 2013

A Nomura research report suggests that China’s local government financing vehicles now pose a major risk for the economy. Their debt stock has surged close to 40% of GDP over the past three years. Profitability is poor, liquidity risks are high, and solvency hinges on government support.

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Risk premia strategies

September 24, 2013

Risk premia strategies can be defined as diversifiable investment styles with fundamental value and positive historic returns. Their main types are (i) absolute value and carry, (ii) momentum, and (iii) relative value. A Societe Generale research report argues that value generation of these styles may be more reliable than that of asset classes and more suitable for combination into diversified portfolios.

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The rise of counter-cyclical fiscal policy

September 21, 2013

A new IMF paper illustrates the changed realities of public macro policy. In times of negative shocks at the zero bound for interest rates, fiscal policy is best suited for stabilizing economies. Monetary policy takes on a support role, securing funding conditions and financial stability. As a side effect of this policy mix, sovereign risk has emerged as a major concern in advanced economies. This suggests that in times of recovery it will also be fiscal rather than monetary tightening that dampens economic growth and overheating.

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Target2 and the euro area crisis

September 17, 2013

Target2 is the real-time gross settlement system of the Eurosystem. It allows central banks to redress reserve losses that result from balance of payment deficits. A working paper of the University of Siena illustrates how Target2 prevented the euro area sovereign crisis from escalating into large-scale defaults and devaluations. Limitations to Target2 could downgrade the monetary union to a fixed exchange rate regime, if international flows become large enough.

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