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Markets break free from central banks, but BIS says risks remain

The rise in bond yields and the value of the dollar since the election of Donald Trump may show a welcome liberation of financial markets from over-dependence on central bank policy, but risks remain, with emerging-market economies especially exposed to a stronger greenback, the Bank for International Settlements said in its Quarterly Review.

Falls in emerging-market credit and share markets following the dollar surge were more muted than in the so-called "taper tantrum" in 2013, but these economies could face challenges as $120 billion of emerging-market companies' dollar-denominated debt comes due in 2017, 10% of the total, the BIS said in the review, released Dec. 11.

Although it should be possible to roll over the bonds and loans, emerging economies could be hit if funding turns scarce, the BIS's head of research, Hyun Song Shin, said in a written statement.

"If investors react to rising yields by selling and exiting the market, their reactions may amplify market disruptions," Shin said.

But although risks remain, markets have continued functioning smoothly despite political upheaval including the U.K.'s vote to leave the European Union and the U.S election victory for the populist Trump, who has promised a $1 trillion fiscal stimulus package.

"It was not central bank utterances or policy decisions that, fundamentally, triggered the market moves. It is as if market participants, for once, had taken the lead in anticipating and charting the future, breaking free from their dependence on central banks' every word and deed. In itself, this is healthy," said the head of the BIS's monetary and economic department, Claudio Borio.

"These events could finally represent the long-awaited beginning of a welcome normalization process from the extraordinary post-crisis conditions. But the jury is still out, and caution is in order."

The relatively benign emerging-market reaction might also reflect expectations that a rise in U.S. growth would boost their exports, the BIS said. Any falls in the values of their currencies, though, might not provide net gains to their economies, as any stimulus to trade might be outweighed by more difficult funding conditions for some countries.

In recent years, the BIS has pointed to concerns that signs of falling liquidity in bond markets might be a source of systemic risk. But in its latest Quarterly Review, the BIS moderated its tone, arguing that if events like October's "flash crash" in the value of the British pound do not cause lasting disruption to markets, they may not necessarily be a cause for concern.

"We may need to get used to them," Borio said. "More generally, the resilience of markets is a tribute to the efforts made to strengthen the capital and liquidity of financial institutions and to encourage better pricing of liquidity risk: stronger institutions make for more robust market liquidity."

The BIS also pointed to the effects of other post-crisis re-engineering of the financial system, with U.S. reforms to prime money market funds slashing funding to banks, prompting lenders to step up bond issuance. Total prime fund assets declined by almost 75%, or $1 trillion, since October 2015. Runs on the funds had been at the center of the global financial crisis.