The drivers of commodity price volatility

July 17, 2013

An empirical paper by Prokopczuk and Symeonidis investigates the drivers of commodity price volatility over the past 50 years. On the economic side inflation changes had been critical  until price growth compressed over the past decade. Also economic recessions have been conducive to larger (industrial) commodity fluctuations. From the 2000s the importance of financial risk variables has gained weight, an apparent tribute to the “financialisation” of commodities trading.

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Why CDS spreads can decouple from fundamentals

July 16, 2013

A Bundesbank working paper provides evidence that Credit Default Swap (CDS) spreads change significantly in accordance with (i) the direction of order flows, (ii) the size of transactions, and (iii) the type of counterparty. Apparent causes are asymmetric information, inventory risk and market power. The implication is powerful. Since transactions do not require commensurate changes in fundamentals and since CDS spreads are themselves used for risk management, institutional order flows can easily establish escalatory dynamics.

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The full scope of U.S. federal government liabilities

July 12, 2013

James Hamilton from the University of California has published some scary numbers on growth and size of U.S. federal government liabilities that are not included in the official debt statistics. Their main constitutents are underfunded Social Security and Medicare liabilities, loan guaranties, and the federal deposit insurance. According to the Hamilton’s research ‘the total dollar value of notional off-balance-sheet commitments came to USD70 trillion as of 2012, or 6 times the size of the reported on-balance-sheet debt’.

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Japanese banks’ vulnerability to rising bond yields

July 10, 2013

Standard & Poor’s research suggests that Japanese banks’ government bond holdings and interest rate risks of have almost doubled over the past 10 years. Against the backdrop of more aggressive reflation policies (view here) this translates into a systemic risk. An increase in long-term yields by 200bps compared to 2012 could already impair the banking system. An increase by 300bps or more could spell broadly based challenges for capital adequacy. A concurrent drop in equity would increase the pressure.

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Asia’s systemic credit risks

July 8, 2013

A new Standard Chartered Research Report investigates pockets of potential credit risk in Asia, by using a new comprehensive set of metrics. China’s overleveraged corporates are at the forefront of concerns, as mentioned in other posts (view here). Japan’s massive 400% debt-to-GDP ratio is a potentially large risk if real interest rates in the country ever increase. India is burdened with a high government debt ratio and an apparently deteriorating profile of corporate debt.

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New rules for euro area bank bailouts

July 6, 2013

Jacob Funk Kirkegaard, senior fellow of the Peterson Institute, has published an excellent summary on the euro area’s political deal for bank recapitalisation and resolution, targeted at breaking “doom loops”, i.e. escalating negative feedback of banking and sovereign solvency troubles. The key parts, from a market perspective, are (i) the possibility of direct recapitalisation of banks through the European Stability Mechanism (even retroactively) and (ii) stricter bail-in rules for private bond and equity owners.

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Metals price distortions and the warehouse system

July 6, 2013

In a short note Macquarie’s commodity research reviews price distortions and prospective changes related to the warehouse system of the London Metals Exchange (LME). Since 2008 LME warehouses have effectively withdrawn over 4 million tons of aluminium from the physical markets, producing a record premium for physical delivery versus exchange spot prices. Premiums have also climbed for other metals. A future increase in mandatory load-out rates could compress premiums but also adds to uncertainty about the resulting adjustment in exchange prices.

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U.S. Fed “tapering”: The basics in the FOMC’s own words

July 1, 2013

Envisaged Fed tapering is simply predicated on five principles: (a) balance sheet expansion will slow and ultimately cease if unemployment declines on a sustained basis to around 7%, (b) the pace of asset purchases remains data dependent, hinging on sustained labor market improvement and financial conditions, (c) tapering is not meant to tighten monetary conditions, (d) tapering does not per se lead to subsequent unwinding of Treasury holdings and may never result in MBS sales, and (e) tapering does not per se bring forward Fed fund rate hikes, which are subject to higher thresholds.

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What we can learn from Asia’s “tapering”

June 30, 2013

J.P. Morgan’s David Fernandez points out that central bank “tapering” (moderation of balance sheet expansion and related monetary accommodation, currently envisaged by the U.S. Federal reserve) has a precedent of sorts. Emerging Asia had ramped up central bank assets for a decade after the 1997-98 crisis, mainly though FX interventions to bolster financial stability and competitiveness. Asia has been unwinding part of that expansion, passively and in line with smaller external surpluses, since 2008. The initial balance sheet expansion did not undermine credibility and price stability. And the subsequent reduction may be interpreted as a positive normalization, reducing the risk of financial bubbles.

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Efficient use of U.S. jobless claims reports

June 29, 2013

U.S. weekly jobless claims are a key early indicator for the U.S. economy and global financial markets. A new Kansas City Fed paper suggests that to use these data efficiently one should first estimate a time varying benchmark for the “neutral level” of claims. Claims above (below) the benchmark would indicate deterioration (improvement) of the U.S. labor market.

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