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”.
Federal Reserve research supports the view that the natural rate of interest in the U.S. has not recovered from its plunge to an unprecedented historical low of close to zero after the great recession. This bodes for protracted problems with the zero lower bound emphasizing the ongoing importance of asset purchases and other non-conventional policy options for central bank credibility.
The European Central Bank’s public sector bond purchases are sizeable and their pace may increase further. However, issue and issuer limits constrain their time horizon. For monetary easing to remain credible and powerful the purchase of uncovered bank bonds and corporate bonds may have to be considered.
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.
Fiscal policy is as important as monetary policy for inflation dynamics. Government debt has features similar to money and affects private wealth and prices. In particular, if monetary policy protects debt sustainability expansionary fiscal policy is inflationary and restrictive fiscal policy is dis-inflationary or deflationary. Moreover, high interest rates are inflationary and low interest rates are deflationary.
Emerging market exchange rates can be catalysts of self-reinforcing trends. Currency appreciation raises both global lenders’ risk limits and EM institutions’ debt servicing capacity. Currency depreciation spurs the reverse dynamics. Their escalatory potential constrains central banks’ tolerance for exchange rate flexibility.
China consumes about one third of the world’s commodities. However, its influence on commodity prices goes beyond that. Chinese institutions are also major users of commodities as collateral. Empirical evidence shows a significant link between domestic lending and global commodity prices, particularly through so-called commodity financing deals.
Empirical evidence shows that non-conventional monetary policy in large advanced economies has shaped financial conditions in the rest of the world. In particular, non-conventional easing has boosted EM bank balance sheets and securities issuance. This goes some way in explaining why the emerging world has become so vulnerable to even just tapering of these policies.
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.
China’s financial distortions are rooted in deposit rate controls and implicit loan guarantees. Low remuneration on bank deposits in conjunction with capital controls have long subsidized banks and borrowers. Loan guarantees have spurred excessive lending and neglect of profitability. Reform is perilous as slowing credit would itself undermine credit quality. An IMF model analysis suggests that a removal of loan guarantees would reduce the capital intensity of the economy.
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.
