A Bank of Italy paper illustrates the detrimental effect of a “negative cost push shock” (for example a commodity price drop) on an economy with low inflation and interest rates close to zero (such as the euro area). In normal times a downside cost shock would boost output. At the zero lower bound for rates, however, it would trigger a contraction, due to rising real rates and debt service.
Explicit management and research of systemic risk is critical for macro trading. First, it supports timely risk reduction or, alternatively, avoidance of uninformed mechanical liquidations. Second, the calibration of tail risk gives a better idea of value-at-risk. Third, systemic risk research helps the efficient and profitable trading of options and credit default swaps. And fourth, know-how of systemic risk is a valuable currency for information exchange within the investment community.
A new CGFS study suggests that [i] bond market makers’ risk tolerance and warehousing have declined and [ii] tighter risk management has augmented pro-cyclicality of liquidity. A gap seems to have opened between more precarious liquidity supply and more voracious liquidity demand, due to rising assets under management at funds that allow daily redemptions.
With public debt ratios at their highest levels in two centuries, financial repression has become inevitable, representing the single viable alternative to default. Moreover, global fiscal tightening is still far from complete. Fiscal restriction will probably diminish in coming years if economic growth is exceeding real interest rates, but may come back with a vengeance if not.
The ECB has introduced a set of new policies that emulate quantitative and qualitative easing. Key measures are targeted long-term repo operations, asset-backed securities purchases, and covered bond purchases. The total net balance sheet expansion is expected to be at least 8% of euro area GDP over two years. Additional asset purchase programmes for corporate and sovereign bonds are possible in order to secure sufficient accommodation and to respond to contingencies.
The recent IMF fiscal monitor shows that advanced countries’ government deficit ratios have continued to narrow, due to fiscal tightening and – in some countries – better economic growth. However, public sector debt has inched up further and more restrictive fiscal policies will be required at some time in the future. Also, emerging market public finances have weakened.
Easy monetary conditions and tighter regulation for banks naturally encourage risk transformation and liquidity creation outside the banking system. Institutional asset managers are key agents of that development. As such shadow banking relies on collateral value rather than external backstops it can make the financial system more pro-cyclical and vulnerable. The size and herding incentives of large asset managers could reinforce excesses.
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.
