Policy measures and reduced short-term risks buoyed markets

Prices of risky assets increased in the three months to early December, despite a weaker outlook for growth. Corporate bond yields fell to their lowest levels since before the 2008 financial crisis as forecasters cut their projections for global economic growth. Equity prices rose during the early part of the period but later fell back. Equity implied volatilities fell close to the historically low levels of the mid-2000s.

Bonds and equities benefited from further loosening of monetary policies and perceptions that some major near-term downside risks to the world economy had diminished. In particular, valuations reacted positively to new policy measures aimed at tackling the euro area crisis. They were also supported by news suggesting that a sharp and prolonged fall in Chinese economic growth was less likely. However, not all downside risks diminished. Uncertainty about the short-term outlook for fiscal policy in the United States encouraged cash hoarding and weighed on the prices of assets most vulnerable to budget cuts.

Significant longer-term risks also remained, including the euro area crisis and those related to the subdued outlook for global economic growth. Given that scenario, some asset prices appeared highly valued in a historical context relative to indicators of their riskiness. Indeed, numerous bond investors said that they felt less well compensated for risk than in the past, but that they had little alternative with rates on many bank deposits close to zero and the supply of other low-risk investments in decline.