Divergences widen in markets: BIS Quarterly Review

Emerging market economies (EMEs) came under pressure in recent months, pushing bond yields higher and domestic currencies lower. Asset prices in EMEs were shaken by the strong dollar, trade tensions, and signs of a slowdown in China. The impact differed across countries; some faced crises. But contagion was limited.

Advanced economy markets also diverged, reflecting differences in the pace of monetary policy normalisation as well as in the macroeconomic fortunes of Europe and the United States. US fiscal stimulus bolstered expectations of higher near-term economic growth but no doubt also of higher bond yields.

Claudio Borio, Head of the Monetary and Economic Department, said further turbulence is likely at some point given that markets in advanced economies are overstretched, financial conditions are too easy and debt, globally, is too high.

"With interest rates still unusually low and central banks' balance sheets still bloated as never before, there is little left in the medicine chest to nurse the patient back to health or care for him in case of a relapse," he said.

The September 2018 issue of the BIS Quarterly Review also:

• Shows that international debt securities issuance now outweighs bank loans as the main driver of international credit to firms, households and governments. The share of international credit denominated in US dollars has grown further since the financial crisis, in particular in EMEs. This increases the potential spillovers from changes in US monetary conditions.
• Explores the reasons for a surge in bank finance to highly indebted or non-investment grade borrowers. These include strong investor demand, a pickup in securitisation and a changed regulatory stance in the United States. The rapid expansion can create vulnerabilities, however.
• Uses BIS banking statistics on Turkey as an example of how to analyse banks' exposure to country risk. At end-March 2018, foreign banks had $223 billion in outstanding loans, securities holdings and other claims vis-à-vis residents of Turkey. But the absolute size of exposures might not be the most relevant indicator. Analysts may, for instance, need to compare exposures with the size of bank capital. The raw figures should also be viewed in the context of banks' business models, financial health, consolidation and accounting practices, and risk transfers.

Four special features analyse recent developments in markets and the economy:

• Raphael Auer and Stijn Claessens (BIS)* examine how cryptocurrencies react to news about possible actions by regulators. Markets respond most strongly to news about the legal status of cryptocurrencies, such as talk of bans (negatively) or the establishment of legal frameworks (positively). The results suggest there is scope for regulation to have an impact.
  "These findings suggest that, far from being beyond the reach of individual national authorities due to their cross-border nature, cryptocurrencies are susceptible to effective interventions by individual jurisdictions," said Hyun Song Shin, Economic Adviser and Head of Research at the BIS.
  "No doubt a globally coordinated policy response would be more effective, but the absence of such coordination need not be an impediment to effective intervention."
• Stijn Claessens, Grant Turner, Feng Zhu (BIS)* and Jon Frost (FSB)* find that fintech credit activity is higher in countries with higher income, less competitive banking systems and less stringent banking regulation. Fintech credit offers an alternative funding source for businesses and consumers, and has the potential to improve access to credit for underserved segments. But regulators face significant challenges in ensuring adequate consumer and investor protection.
• Ryan Banerjee and Boris Hofmann (BIS)* find that "zombie" firms - entities which appear to be insolvent but keep on operating - have been increasing in number since the late 1980s.This may be linked to the downward trend in interest rates over the same period. Zombies weigh on economic growth because they are less productive and divert investment and employment from better-performing peers.
• Benjamin Cohen, Peter Hördahl and Dora Xia (BIS)* review ways to estimate the term premium embedded in bond yields, ie the risk premium demanded by investors. Possible drivers include uncertainty, official sector purchases, the business cycle and regulation. Term premia have been low in the United States and euro area in recent years, helping to flatten the yield curve.

*  Signed articles reflect the views of the authors and not necessarily those of the BIS or the FSB.