By CentralBankNews.info
Subdued volatility in financial markets, low inflation and a simultaneous expansion in advanced and emerging market economies that has not been seen for a long time continues to boost international bank credit and thus debt, raising the question of how vulnerable balance sheets may be to higher interest rates, according to the Bank for International Settlements (BIS).
By the end of March the stock of international bank claims rose another 1.7 percent year-on-year to a total of $32 trillion with U.S. dollar credit to the non-financial sector outside the U.S. rising further to $8.2 trillion, BIS said in its September quarterly review.
“The low financial market volatility was remarkable,” said Claudio Borio, head of BIS’ monetary and economic department, about the so-called “Goldilocks” scenario in which low inflation and global growth continues to boost the “risk-on” phase in financial markets.
Concern over a simultaneous tightening of monetary policy in major economies in the first quarter of the year faded in the second quarter as bond yields retreated, stock markets rose and the U.S. dollar fell, whetting investors appetite for emerging market assets.
Propelled by the issuance of debt securities by borrowers from emerging markets, U.S. dollar credit to borrowers from emerging markets rose further to $3.4 trillion at the end of the first quarter, with the bulk of the increase by residents of Africa and the Middle East, especially through bond issues by governments in oil-exporting countries.
The decline in the U.S. dollar has also led to widespread use of carry trades, with large net short positions in funding currencies, such as the yen and Swiss franc, and large net long positions in EME currencies and the Australian dollar.
In a sign of what Borio describes as “credit market exuberance,” government debt in emerging market economies totaled $11.7 trillion at the end of 2016, more than twice the figure at the end of 2007, before the global financial crises, with Brazil, China and India accounting for around $8 trillion of that total.
But debt is not just rising in emerging markets, but also in developed markets, with leverage conditions in the U.S. at the highest since the beginning of this millennium and similar to those in the early 1990s when corporate debt reflected the legacy of the leverage buyout boom of the late 1980s.
“Taken together, this suggests that, in the event of a slowdown or an upward adjustment in interest rates, high debt service payments and default risk could pose challenges to corporates, and thereby create headwinds for GDP growth,” BIS said.
Equity market investors are now using record amounts of margin debt to lever up their investments although equity valuations appear stretched by historical standards. Outstanding margins debt is now substantially higher than during the dot come boom and around 10 percent higher than its previous peak in 2015.
The rise in margin debt comes as valuations of equity markets become stretched, according to traditional valuations methods, with long-run price/earnings ratios above averages.
But BIS also found that given the unusually low bond yields, valuations may not be out of line as bond yield premium remain well below historical averages.
“This suggest that equity markets continue to be vulnerable to the risk of a snapback in bond markets, should term premia return to more normal levels,” BIS said.
Click to read the BIS Quarterly Review, September 2017.
