On December 7, 2014, the Bank for International Settlements (BIS) issued its latest
quarterly review. Looking back at the year, and the quarter in particular, BIS sees signs of a buoyant global economy, however tempered by indications of some fragility.
"Markets rebounded quickly as economic concerns faded and some major central banks further eased monetary policy. In particular, the Bank of Japan and the ECB provided further stimulus, while the Federal Reserve ended its QE3 asset purchase programme. These opposing moves unsettled exchange rates, with the dollar appreciating against most other currencies."
"These abrupt market movements were even more pronounced than similar developments in August, when a sudden correction in global financial markets was quickly succeeded by renewed buoyant market conditions. This suggests that more than a quantum of fragility underlies the current elevated mood in financial markets."
Among the signs of fragility noted by BIS were:
- Intermittent volatility spikes;
- August and mid-October global equity market drops (whose extreme intraday price movements how sensitive markets have become to even small surprises);
- Some deterioration in liquidity as a result of hedge funds and other large investors holding large net short positions in eurodollar futures, which needed to be unwound quickly.
Despite these red flags, BIS notes that the August/October downturn rebounded quickly and some asset classes reached new records by the end of November.
BIS also warns that growing uncertainty about the global economic outlook and increasing geopolitical tensions, along with diverging macroeconomic developments and monetary policy actions also add to the sense of fragility. Falling oil and other commodity prices are a potential bright spot in the upcoming year. There will be winners and losers, with net importers benefitting, and net importers feeling the pinch. BIS predicts, however; that lower commodity prices are likely to be a net positive to the overall global economy.
In addition to their assessment of the buoyant, yet fragile state of the global economy, BIS provides the following takeaways from the quarterly report:
- International banking activity expanded for a second consecutive quarter between end-March and end-June 2014, partially reversing the sustained contraction experienced in 2012 and 2013. The annual growth rate of cross-border claims went up to 1.2% in the year to end-June 2014, its first move into positive territory since late 2011.
- Banks' cross-border claims on emerging market economies (EMEs) continued their recovery from the "taper tantrum" of mid-2013.
- Increases in the second quarter of 2014 were concentrated in Asia, with China again receiving substantial inflows.
- Claims on China continued to grow at annual rates of close to 50%. The latest increase took the outstanding stock of cross-border claims on China to $1.1 trillion, by far the largest in the emerging market world and the seventh largest overall.
- Cross-border claims on emerging Europe declined, with credit to Russia, Hungary and Ukraine contracting the most.
- Positions in over-the-counter (OTC) derivatives retreated slightly in the first half of 2014. The notional amount of outstanding contracts fell to $691 trillion at end-June 2014, from $711 trillion at end-2013.
- Central clearing by market participants advanced further, reaching 27% of notional credit default swaps (CDS) outstanding at end-June 2014, up from 23% one year earlier. In addition, bilateral netting agreements reduced the net market value of outstanding CDS contracts, which provides a measure of exposure to counterparty credit risk, to 23% of their gross market value.
- The classification by sector of foreign affiliates of EME non-financial corporations sheds light on the risk profile of their offshore debt. Non-financial affiliates are presumably more likely than financial affiliates to be engaged in activities other than providing funding for the parent. The split between financial and non-financial subsidiaries varies greatly across countries and industries.