Thursday, December 17, 2015

Year End Comments by BIS Chief Economist Claudio Borio

Claudio Borio of the BIS (Bank for International Settlements) gave a recap of where he sees the markets as we come to the end of 2015. He says the markets have been fairly calm, but it's "an uneasy calm". Below are some selected quotes from his recent speech.

On-the-record remarks by Mr Claudio Borio, Head of the Monetary & Economic Department, and Mr Hyun Song Shin, Economic Adviser & Head of Research, 4 December 2015.
Claudio Borio
"Calm has reigned over financial markets, but it has been an uneasy calm.
We left the markets in turbulence in the previous quarter. Then, just as suddenly as it had arrived, the turmoil gave way to calm. Markets roiled in August and September only to rebound in October. Stock markets recorded their strongest one-month rally in recent years. Commodity prices initially bounced back. Emerging market currencies stabilised alongside portfolio flows. Credit spreads narrowed. Volatilities declined. On the face of it, the turbulence turned out to be more like a brief summer storm than autumn thunder heralding the arrival of a long winter.
As events unfolded, the picture did not change much. By and large, financial markets took a brief pause. And they waited. They waited with bated breath for what they regarded as a highly likely lift-off by the Federal Reserve in December."
. . . . .
"Zoom in on the fixed income asset class and a number of anomalies suggest that not all is well in markets. Surprisingly, despite the higher credit risk involved, US swap rates have actually been lower than the corresponding Treasury rates. And even on a currency-hedged basis there has been a persistent premium for those wishing to borrow dollars - so much for economic textbooks' faith in covered interest parity. Thus, market-specific supply and demand imbalances are not being arbitraged away as would normally be the case. Financial institutions, notably banks, are not using their balance sheet capacity as they once did."
". . . . .  in the background, interest rates continued to remain exceptionally low. Even as the Federal Reserve appeared to be approaching lift-off, US 10-year Treasury yields were hovering around 2.2% in late November - a telltale sign of an unusually shallow expected path for the policy rate. Moreover, following clear signals of ECB accommodation, some 2 trillion, or fully one third, of euro area sovereign paper was trading at negative yields - a new peak. Market participants also kept wondering whether the Bank of Japan might ease further. Monetary policy divergence loomed ahead, with potentially significant implications for exchange rates and market adjustments. At the same time, interest rates, current and expected, continued to test the boundaries of the unthinkable day after day - and this despite the matter-of-fact tone of much of the running commentary. Familiarity breeds complacency.
Under such extraordinary conditions, it is not surprising that markets remain unusually sensitive to central banks' every word and deed. Just think of the market gyrations following yesterday's ECB decision to ease even further, but to an extent that fell short of market expectations. Hyun will say more about this shortly.
Against this backdrop, it is hard to imagine how the calm could be anything but uneasy. There is a clear tension between the markets' behaviour and underlying economic conditions. At some point, it will have to be resolved. Markets can remain calm for much longer than we think. Until they no longer can."

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