The secular decline in the global equilibrium real interest rate

January 2, 2016

A new Bank of England paper finds a 450 bps decline in global equilibrium real interest rates over the past 35 years, due to a fundamental divergence: savings preferences surged on demographics, inequality and EM reserve accumulation, while investment spending was held back by cheapening capital goods and declining government activity. More recently, fear of secular stagnation has compounded the real rate compression.

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Collateral framework: risks and policies

December 27, 2015

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.

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How growing assets-under-management can compromise investment strategies

December 23, 2015

If investment funds maximize assets-under-management and end-investors allocate to outperforming funds, the investment process is compromised. A new theoretical paper suggests that asset managers may prefer portfolios with steady payouts (or steady expected mark-to-market gains) and neglect risks of rare large drawdowns, potentially leading to complete failure of parts of the options market.

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Using volatility to predict crises

December 12, 2015

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.

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The role of macroprudential policy

December 5, 2015

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.

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The impact of the ECB asset purchase programme

November 19, 2015

ECB research suggests that its 2015 asset purchase programme significantly compressed term and credit spreads. Unlike previous asset purchases, it did not tackle financial distress. It functioned mainly through the broad compression of risk premia and spill-over to non-targeted assets.

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How nominal interest rates can become deeply negative

November 10, 2015

A recent IMF paper suggests that sizeable negative policy rates could be implemented in developed economies. The key would be a variable deposit fee at the central bank cash window that can enforce value decay of paper currency relative to electronic money. Despite legal and economic issues, the proposal is disconcertingly practical in light of the expansion of electronic payments. Its mere consideration would be a tail risk for fixed income markets.

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The growing concerns over market liquidity

November 7, 2015

Market liquidity accommodates securities transactions in size and at low cost. When it fails the information value of market quotes is compromised, potentially triggering feedback loops, margin calls and fire sales. With shrinking market making capacity at banks, the fragility of liquidity in both developed and emerging markets has probably increased. The rise of larger and more pro-cyclical buy-side institutions seems to enhance this vulnerability.

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How current accounts mislead FX markets

October 31, 2015

A common fallacy is that current account deficits measure dependence on external financing. In reality, external balances and cross border financing are only vaguely related. Vulnerability to “stops” in financial flows does not depend on trade and capital flows (“net concept”) but only on the volume and origin of financing (“gross concept”). Currency crises are not about current accounts that need to adjust, but about funding gaps that need to be closed.

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A mini briefing on global public finance trends

October 30, 2015

According to IMF estimates the structural government deficit in the developed world has returned to its pre-crisis level. This reflects cumulative fiscal tightening of over 4% of GDP since 2010. Government debt ratios remain elevated, however, at close to 105% of GDP, some 33%-points above pre-crisis levels, leaving public finances more sensitive to real interest rates. Emerging market fiscal indicators continue deteriorating.

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