Sunday, December 7, 2014

Bank of International Settlements Issues a New Warning on Markets

Sometimes I wonder if the Bank of International Settlements (BIS) is reading the blog here. I joke of course. But in their new Quarterly Review just released today they issue yet another warning about "the growing fragility hidden beneath the markets buoyancy". 

This article in the Financial Times summarizes the new BIS report. There is a lot of information in this report so we will just pick out some key quotes below that relate to some things we have covered here on the blog. Please read the linked articles to get full context. (Financial Times may require you to register to read their article)


All year long we have covered the ongoing warnings from both the IMF and the BIS that Central Bank easing policies may be causing financial markets to overheat and build up into bubbles. We have also pointed out that we will not know if the global economy (and the US economy) can stand on its own feet without artifiicial support from Central Banks until they actually try it. We have also covered several articles that mention the concern by the BIS, the IMF and others as to what is going to happen if the Fed does try to raise interest rates.

In this BIS report, they once again issue warnings about all this and state clearly that there is risk in the markets. Below are some key quotes from Claudio Borio (Head of the BIS Monetary and Economic Department):

"Once again, the financial market scene was far from uneventful during recent months. Volatility spiked in mid-October. Stock prices fell sharply and credit spreads soared. US Treasuries were exceptionally volatile, at least intra-day - even more than at the height of the Lehman crisis. And yet, just a few days later, the previous apparent calm had returned. Volatility in most asset classes had sunk back down to the depths of the previous two years. And as benchmark sovereign yields sagged once more, the valuation of riskier assets recovered at least part of the lost ground. So, what is going on?
It is too early to say what exactly triggered these sharp, if brief, price swings. As we speak, researchers and market regulators in the United States and elsewhere are sifting through tons of data to understand every market heartbeat during those turbulent hours on October the 15th. That said, some preliminary reflections are in order. No doubt, one-sided market positioning played a role, as participants were wrong-footed. But is there more to it?
It is, of course, possible to draw comfort from recent events. Those who do so stress the speed of the rebound. At the same time, a more sobering interpretation is also possible. To my mind, these events underline the fragility - dare I say growing fragility? - hidden beneath the markets' buoyancy. Small pieces of news can generate outsize effects. This, in turn, can amplify mood swings. And it would be imprudent to ignore that markets did not fully stabilise by themselves. Once again, on the heels of the turbulence, major central banks made soothing statements, suggesting that they might delay normalisation in light of evolving macroeconomic conditions. Recent events, if anything, have highlighted once more the degree to which markets are relying on central banks: the markets' buoyancy hinges on central banks' every word and deed.
The highly abnormal is becoming uncomfortably normal. Central banks and markets have been pushing benchmark sovereign yields to extraordinary lows - unimaginable just a few years back. Three-year government bond yields are well below zero in Germany, around zero in Japan and below 1 per cent in the United States. Moreover, estimates of term premia are pointing south again, with some evolving firmly in negative territory. And as all this is happening, global growth - in inflation-adjusted terms - is close to historical averages. There is something vaguely troubling when the unthinkable becomes routine."

The Financial Times article linked above observed this about the BIS report:

"Global financial policy makers have sounded the alarm about the impact of a resurgent US dollar on emerging markets, where companies have racked up large debts denominated in the American currency."

"The Bank for International Settlements, known as the central bankers’ bank, warned on Sunday in its Quarterly Review that a prolonged rally in the dollar could expose financial vulnerabilities in emerging markets by damaging some companies’ creditworthiness."

. . . . . . .

"Mr Borio said: “Should the US dollar, the dominant international currency, continue its ascent this could expose currency and funding mismatches by raising debt burdens. The corresponding tightening of financial conditions could only worsen once interest rates in the US normalise.”

My added comments:

Once again we have significant warnings being issued by the Central Bank for Central Banks (the BIS). They say they have concern that there is "hidden fragility" behind markets that appear buoyant. They state that the rising US dollar "could expose financial vulnerabilities in emerging markets by damaging some companies creditworthiness". Then they go on to add that if the US dollar keeps rising "financial conditions could only worsen once interest rates in the US normalise". They even say that the only reason markets are stable right now is because of artificial support from Central Banks and "market buoyancy hinges on central banks every word and deed". This is hardly a vote of confidence that markets are stable and standing on their own feet.

The message is clear. The BIS thinks the markets are fragile despite being at all time highs. They think the US dollar rise poses risks to the world "raising debt burdens". If interest rates start rising (normalise), the risks only go up. This all ties in with what we have covered here all year long.

This also provides support for Jim Rickards views. He thinks the Fed will not raise interest rates, the markets are unstable, and that a rising US dollar suggests failure by the US Fed to get the dollar lower. Basically everything the BIS is talking about in this report. 

Keep in mind that the markets and financial media are anticipating a rise in interest rates by the FED in 2015 because the economy is doing so well. 2015 is going to be interesting.

Update 12-11-14: Here is another new article about BIS warnings.

Added note 8-6-15: A full list of systemic risk warnings can be found on this blog page 

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