The Bank for International Settlements (BIS) has released its latest quarterly assessment, highlighting a further rise in risk assets between December 2020 and February 2021, and noting that a sharp rise in global bond yields over the past month could completely change the outlook for financial markets.
The report also mentions that the number of corporate bankruptcies is expected to rise as credit support measures contract, some industries downsize, and corporate liquidity buffers run out.
Risk appetite heats up as retail holdouts add to market turmoil
Regarding risky assets, the BIS noted in its report.
“Accommodative monetary policy, expectations of fiscal stimulus, and optimism about the economic recovery form the backdrop for the rise in risky assets.”
The report noted that the rising fervor in corporate bond issuance (especially for lower-rated companies) reflects the trend in market risk appetite.
According to BIS, many stock indices hit new highs in February, and the growing influence of retail investors on market dynamics is reminiscent of the asset bubble period of the late 1990s.
Indeed, the recent frenzied speculation by retail investors in stocks such as GameStop has contributed to the market shocks. Claudio Borio, head of the Monetary and Economic Department at the Bank for International Settlements, said this is typical of the frenzied participation of retail investors.
The unprecedented stimulus will trigger Inflation, and major changes in the U.S. debt market will tend to push up global borrowing costs. In addition, in a period of low interest rates and high price-earnings ratios, stock yields are more sensitive to monetary policy news, and retail investors are increasingly exerting influence on the stock market, with “significant and volatile activity” that could amplify price volatility.
Borio said.
“The recent market turmoil confirms that rising bond yields and the frenzy of reflationary trading have changed the outlook for financial markets. People only see low interest rates in front of them, yet now they have begun to wonder how long these conditions will last.”
Analysts drew comparisons to the tapering scare of 2013. Bond yields rose sharply in response to news that then-Fed Chairman Ben Bernanke had released news of a slowdown in asset purchases.
Borio said whether the market will suffer another tapering panic depends first on how the world economy grows, followed by how central banks react to rising bond yields. Central banks must figure out what rising bond yields mean for the central bank’s goals and respond accordingly to control inflation and avoid financial markets spiraling out of control.
$1 trillion in credit losses incurred during the Epidemic
The BIS also reviewed banks’ loan loss provisioning during the epidemic, noting that banks’ forward-looking assessments of credit losses were revised upward at the beginning of the epidemic. Using a sample of 70 large internationally active banks reporting under ECL accounting, provisions total $161 billion in the first half of 2020, compared to $50 billion in the second half of 2019.
However, as the economic outlook improved in the second half of 2020, banks reduced their quarterly provisions, with some banks having even negative provisions. In the third quarter, the sample banks’ total provisions fell to $29.5 billion, close to the level before the epidemic.
By the end of the year, the 57 banks that had released fourth-quarter financials had drawn down a total of $20 billion in provisions, with six of them announcing reductions in loan loss provisions, although the reductions were still significantly smaller than the amount of loan loss provisions that had been increased in the previous three quarters.
The BIS quarterly report analyzed redemptions from money market funds in March 2020 and found that large investors paid little attention to the liquidity position of individual funds, with portfolio managers responding to the surge in redemptions by hoarding liquid assets.
Another report found that non-U.S. banks’ U.S. dollar liabilities grew in 2020 despite market stress and reduced funding from U.S. and offshore money market funds. Non-U.S. banks are said to have witnessed a massive shift in U.S. dollar funding sources to other non-bank financial institutions.
Currently, the market is generally bullish on emerging market assets, particularly in East Asia. The report also analyzes and discusses how much pressure the outbreak may put on corporate credit in G7 countries, Australia and other regions.
The BIS noted that because the sectors most affected by the epidemic accounted for a smaller share of total corporate borrowing, credit loss rates are likely to be lower than those seen during the 2007-09 financial crisis. However, the analysis predicts that bankruptcies resulting from the new crown could lead to credit losses of up to $1 trillion, more than was expected before the epidemic.
While corporate bankruptcy rates remain “fairly low” in most countries, despite the sharp decline in economic activity, “bankruptcy rates are expected to rise as measures to support credit gradually resume, new spending habits and business practices accelerate sector-specific layoffs, and some firms run out of liquidity buffers “.
“The increase in the number of corporate bankruptcies will generate credit losses that will need to be absorbed by the financial system or taxpayers.”
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