BIS Quarterly Review, December 2011

News on the euro area sovereign debt crisis drove most developments in global financial markets between early September and the beginning of December. Amid downgrades and political uncertainty, market participants demanded higher yields on Italian and Spanish government debt. Difficulties in meeting fiscal targets in a recessionary environment weighed on prices of Greek and Portuguese sovereign bonds. Conditions stabilised somewhat in October on growing optimism that the end-month EU summit would propose comprehensive measures to tackle the crisis. But by November, investors were growing sceptical about the adequacy of some of these measures. Sovereign bond yields then rose across the euro area, including for higher-rated issuers. Meanwhile, financial institutions with direct exposure to euro area sovereigns saw their costs and access to funding deteriorate. Affected banks took measures to further reduce leverage, selling assets and tightening credit terms. Financial institutions also sold certain types of assets to counter increases in the volatility of their portfolios. This included emerging market securities, whose prices plunged in September and fell again in November, while those of safe haven assets rose in a corresponding flight to quality. More...

BIS reporting banks reduced their cross-border claims on residents in developed economies in the second quarter of 2011 but increased cross-border lending to emerging markets for the ninth quarter in a row. In absolute terms, lending to residents of the United States shrank the most (by $155 billion or 2.8%). Claims on the United Kingdom and Japan also fell (by $52 billion or 1.1% and by $32 billion or 4.1%, respectively), whereas claims on residents of the euro area remained virtually unchanged, inching up by a mere $7.5 billion (0.1%). Among the emerging market regions, increased cross-border lending to China ($68 billion or 16%) drove up claims on borrowers in Asia-Pacific (up $108 billion or 9%). Cross-border claims on residents of Latin America and the Caribbean and of emerging Europe also increased (by $33 billion or 5.9% and $10 billion or 1.2%, respectively), whereas claims on residents of Africa and the Middle East shrank by $6.3 billion or 1.2%. High shares of cross-border claims and short-term international claims in their debt to BIS reporting banks could make Asia-Pacific economies more vulnerable to sudden capital flight through the banking system. That said, the risk of a withdrawal of lending triggered by a possible deleveraging by euro area banks is highest in emerging Europe. Issuance of international debt securities dropped in the third quarter of 2011. Deteriorating market conditions compounded the usual summer slowdown in the northern hemisphere. This resulted in a 16% decline in completed global gross issuance. At $1,663 billion, this was the lowest since end-2005. Net issuance of international debt securities slid to $142 billion, the second lowest level since end-1998. More...

This article presents an overview of widely practised short-term multicurrency investment strategies such as carry trade, momentum and term spread strategies. We provide evidence on their downside risk properties and illustrate their performance over historical episodes of financial market turmoil. We show that the strategies exhibit substantial tail risks and that they do not perform uniformly during distress periods in global markets. Interestingly, equity market investments feature even greater downside risk.

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For now, effective capital controls allows the Chinese authorities to retain regulated deposit and lending rates, quantitative credit guidance and bond-market rationing. Relaxing capital controls would put these policies at risk. Reserve requirements can be extended to bank inflows from the offshore market, but only at a cost.

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Global liquidity has become a key focus of international policy debates over recent years. The concept of global liquidity, however continues to be used in a variety of ways and this ambiguity can lead to potentially undesirable policy responses. This feature attempts to further the understanding of the global liquidity concept, its measurement and policy implications. It argues that policy responses to global liquidity call for a consistent framework that considers all phases of global liquidity cycles, countering both surges and shortages.

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This article analyses the effectiveness of the asset purchase programmes implemented by the Federal Reserve and the Bank of England. Both the Federal Reserve's Large-Scale Asset Purchase (LSAP) programme and the Bank of England's Asset Purchase Facility (APF) had a significant impact on financial markets when the first stages were announced, but the effects became smaller for later extensions of the programmes. Applying a methodology developed by D'Amico and King (2010), we estimate that the lasting reduction in bond supply via central bank asset purchases lowered government bond yields significantly. The effect is largely similar for the LSAP and the APF. Our estimations also suggest that the Federal Reserve's new maturity extension programme (MEP) should have an effect on longer-term Treasury bond yields comparable to that of the outright asset purchases under the LSAP.

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From June 2011, the BIS credit derivatives statistics provide more granular information on the types of risks transferred through credit default swaps by different groups of counterparties. The new data suggest that reporting dealers have used some hard-to-value credit derivatives to transfer credit risk to shadow banks, possibly exposing these counterparty groups to valuation risks. The data also show that some financial counterparties have sold protection against defaults in the same sector on a net basis.

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