Swings in market sentiment were particularly pronounced in the early months
of 2001. While it was clear that the US economy had begun to slow substantially,
market participants vacillated in their views about the likely length and depth
of the slowdown, the extent to which it would spread to Europe and elsewhere,
and its ramifications for corporate earnings and credit quality. Inter-meeting
policy rate cuts by the US Federal Reserve buoyed the markets in general, while
company profit warnings tended to depress the equity markets. By April,
investors seemed to be looking beyond a brief slowdown in corporate earnings to
a robust recovery.
Compared to equity investors, participants in fixed income markets seemed to
be less prone to change their views. As short-term interest rates fell against a
background of confidence in an imminent recovery, yield curves in both US
dollars and euros tended to become progressively steeper and credit spreads
narrower.
The international debt securities market
The decline of interest rates and narrowing of credit spreads brought
borrowers with low and medium ratings back in force. Net issuance of straight
fixed rate bonds and notes in the international market surged to an all-time
high of $204 billion during the first quarter of 2001. Nevertheless,
aggregate net issuance declined because of a sharp contraction in money market
borrowing. Gross announced issuance of bonds and notes rose by $140 billion
over the previous quarter, while repayments increased by $72 billion.
The shift from short-term to long-term funds represented a return to more
normal patterns after the previous quarter's unusually high volume of money
market issuance. Credit rating downgrades and a reluctance of banks to provide
backup liquidity facilities made it more difficult for some firms to borrow in
the commercial paper market, and they turned to a newly receptive bond
market.
Emerging economies also returned to the bond market, albeit in a modest way.
Net issuance by these borrowers amounted to $6 billion in the first quarter,
after a quarter of net repayments. As a group, countries in Latin America and
non-industrial Europe raised funds, while those in Asia made repayments.
Derivatives markets
The dollar value of turnover on derivatives exchanges rose by a record amount
in the first quarter of 2001, driven by a 55% increase in turnover in
exchange-traded interest rate contracts. Activity in short-term contracts was
especially strong, surging by 61%. The impetus for all of this activity was
apparently the surprise cut in US policy rates in early January.
In contrast to exchange-traded activity, the expansion of the notional amount
of outstanding over-the-counter (OTC) contracts slowed down considerably in the
second half of 2000. This represents a significant departure from
previous patterns since in recent years the growth of OTC market activity had
consistently outpaced that on exchanges. The most notable feature of the
moderation in OTC market activity was a decline in inter-dealer transactions,
particularly in euro-denominated interest rate swaps.
The international banking market
The fourth quarter of 2000 saw a remarkable surge of interbank
activity. The latest BIS locational banking statistics show an increase of
cross-border claims by $400 billion, $302 billion of which comprised
interbank lending. Much of this interbank activity was driven by efforts to
recycle large inflows from oil-exporting countries and emerging economies in
East Asia to borrowers in the United States and other industrial countries.
The surge in fourth quarter activity brought the rise in cross-border claims
for the year to $1.2 trillion, a quadrupling over 1999 levels. As in the
case of the quarterly increase, the annual rise was dominated by interbank
activity, which is typically inflated by a multiplier in the recycling process.
Lending to non-bank borrowers actually slowed to $55 billion in 2000, about
half of what it was in 1999. Cross-border purchases of securities continued
their upward trend, driven by a sixfold increase in purchases of securities
issued by US residents.
Banks' cross-border claims on emerging economies continued to contract in the
fourth quarter of 2000, by $6 billion. A rise in claims on Brazil and
Turkey was more than offset by a decline in claims on Korea and other Asian
economies. Considering changes in banks' claims as well as emerging economies'
cross-border deposits, net outflows from emerging economies to international
banks during 2000 even exceeded average annual outflows during the financial
crises of 1997-99.
Stress testing in practice
A feature article presents the results of a survey of stress testing
practices conducted in May 2000. Forty-three major commercial and investment
banks from 10 countries responded to questions about the material risks they
faced. The survey suggests that stress testing has become an integral part of
the institutions' risk management. In responding to the tests, risk managers
seem to take into account their position in the market and the strategic aspects
of risk management. In particular, there are no strict mechanical rules for
responding to instances in which risk limits are breached. Decisions are taken
on a case by case basis.
Do macro announcements still drive the US bond market?
A second feature article explores the extent to which various macroeconomic
announcements still lead to sharp changes in the price of the five-year US
Treasury note. The article compares announcement effects in 1999 to those in
1993-94, relying on a previous study that looked at the earlier period. The
article reports five basic results. First, the largest short-term price
movements in the Treasury market were still associated with macroeconomic
announcements, but the market seemed to react to more announcements than before.
Second, announcements continued to trigger higher than average price volatility.
Third, the surprise content of announcements in 1999 was smaller than before.
Fourth, the price response to surprises in non-farm payrolls, the single most
important announcement, was no longer consistent in sign although the price
response to inflation surprises was similar to that previously found. Finally,
there is no evidence that large equity price changes drove bond price movements
in 1999.
Is there a "Nasdaq effect" in emerging equity markets?
A third special feature investigates whether there is a "Nasdaq
effect" in emerging equity markets. The article asks specifically whether
changes in this index lead to movements in the equity markets even after
accounting for common global and sectoral components. The analysis suggests that
changes in the Nasdaq Composite have little additional explanatory power beyond
these components, although a "Nasdaq effect" may be part of the global
factor. However, the analysis also points to the possible instability in the
examined relationships, particularly during 2000.
Read the publication: BIS Quarterly Review June
2001