China consumes half of the world’s base metal supply. Its housing market is the most metal-intensive large sector. A new quantitative study shows that China housing has been a key determinant of global metal prices during the boom of the 2000s and the bust since 2014. It is a crucial ingredient of forecasting models for directional commodity trading.
The contribution of life insurers to systemic risk has increased, according to the IMF Global Financial Stability Report. They now hold about 12% of global assets and common exposure to aggregate risk has risen. Insurers are vital for key market segments such as corporate bonds and securities lending. Meanwhile, low global interest rates have aggravated duration gaps, increased interest rate sensitivity and may encourage greater risk taking.
Pension funds have three types of motivations for herding: rebalancing rules, the effects of regulatory changes and peer pressure of senior executives. A new empirical study detects all of these in the trading flows of the large Dutch pension funds. These flows offer opportunities for contrarian traders that provide liquidity to the “herd”.
New theoretical work shows that money markets remain fragile as long as there is a connection between asset prices, secured funding and unsecured funding. The degree of fragility depends on leverage in the financial system. Central banks can alleviate acute liquidity stress but cannot easily reduce financial system leverage. Hence fragility remains even with ultra-easy monetary conditions.
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.
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.
A long-term empirical study finds two fundamental links between market volatility and financial crises. First, protracted low price volatility leads to a build-up of leverage and risk, making the financial system vulnerable in the medium term (Minsky hypothesis). Second, above-trend volatility indicates (and causes) high uncertainty, impairing investment decisions and raising the near-term crisis risk.
Macroprudential measures are often seen as a counterweight to ultra-easy monetary policy in the developed world. BIS research cautions against this expectation. Macroprudential policies are largely new and untested, have worked best as a complement (not offset) to monetary policy, and focus on specific sectors, such as banking and housing.
Asset managers can use leverage to enhance returns. Outside hedge funds, such leverage is modest as share of assets under management. However, considering the huge volume of assets, changes in buy-side leverage still have a significant impact on financial conditions, particularly in emerging markets. Also, both theory and empirical evidence suggest that leverage is pro-cyclical.
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.
