BIS Quarterly Review, November 1999
Introduction
The continued rise of long-term interest rates in Europe and the United States does not appear to have hampered issuing activity in the international securities markets in the third quarter of 1999. The volume of new securities moderated slightly but remained well above the quarterly average for 1998. In fact, primary market activity in the money and bond markets together in the first three quarters of the year reached $1.8 trillion, already surpassing that for 1998 as a whole.
An extraordinary widening of spreads on US dollar and sterling interest rate swaps was perhaps the most striking market development during the third quarter. Spreads on US dollar swaps in particular exceeded the levels reached during autumn 1998. This time, however, credit risk did not appear to be the driving force, since there was no corresponding rise in credit tiering in the US corporate bond market. Instead, the wide swap spreads may have reflected liquidity pressures, with the rise in US corporate bond issuance leading to an unusual amount of swap hedging activity by underwriters and investors. At the same time, the memory of last autumn's events and a related cutback in the amount of market-making capital seem to have made swap dealers reluctant to provide additional liquidity.
Although there was no credit event of the magnitude of last year's Russian debt moratorium, financial market participants appear to have been troubled by a succession of disturbing announcements. In July, Daewoo, Korea's second largest conglomerate, defaulted on its domestic and foreign loans, triggering a run on investment trusts and disrupting the onshore securities markets. Shortly afterwards rumours began to circulate that Ecuador would miss an August payment on some of its outstanding Brady bonds. Notably, these episodes did not create contagion on a scale comparable to that observed in 1997 and 1998.
Unfazed by the turbulence of last year and the more recent difficulties of emerging market borrowers, the international bond market has recovered rapidly since the beginning of the year. Large benchmark issues have led the surge in the primary market. Much of the expansion in international business since the beginning of the year has resulted from the funding operations of financial institutions. The market turbulence triggered by the Russian debt moratorium in August 1998 had forced such borrowers to temporarily pare down issuance. However, the need to boost capital ratios, to finance expansion into new areas and to fund corporate mergers and acquisitions has led banks to return in force to the securities markets. Moreover, as anticipated by various observers, the introduction of the single European currency has led to a jump in euro-denominated issuance. Business in the US dollar continued to exceed that in the euro in the third quarter, but that margin narrowed. Dollar and euro issuance now jointly account for four-fifths of new announcements, making the international bond market virtually a two-currency market.
In the syndicated loan market, activity in the third quarter reflected a slowing of merger-related facilities from the brisk pace of the previous quarter. The detailed BIS international banking statistics available for the second quarter of 1999 confirm the recovery of international bank lending to the non-bank sector in the early part of this year. In contrast, there was an unusually large decline in interbank claims, which can be attributed partly to the transition to the euro and to a cutback in Japanese inter-office transactions. International banking activity was also influenced by banks' further retrenchment from emerging market economies.