BIS Quarterly Review, August 1999

BIS Quarterly Review  | 
23 August 1999


A measure of stability returned to global financial markets during the second quarter of 1999 as credit and liquidity spreads tended to settle between crisis and pre-crisis levels. At the same time, global bond markets witnessed an unusual degree of decoupling between US and European long-term yields, with the 10-year yield differential widening to nearly 150 basis points in June. While signs of inflationary pressures and a bias towards tightening by the US Federal Reserve pushed up US bond yields sharply, sluggish economic growth and an anticipation of monetary easing in the euro area mitigated the increase in European yields. The general rise in long-term interest rates dampened equity markets only temporarily, and the quarter ended with strong stock market rallies.

In currency markets, while positions in risk reversals suggested a modest but persistent bias in the worries of market participants towards a strong appreciation of the yen against the dollar, there was no particular concern about a sharp weakening of the euro. These views were unusual given the lack of a clear trend in the yen and the slide of the euro during the quarter. While reports of official intervention in mid-June may have staved off an appreciation of the yen, options traders evidently thought that upward pressures on the yen would continue. During the same period, the currencies of emerging markets in Asia regained stability against a background of economic recovery.

A record volume of international securities issues in the second quarter of 1999 along with a drop in repayments led to a significant increase in net financing flows. In the face of the global rise in long- term interest rates, activity was supported by the ongoing wave of mergers and acquisitions, the rapid development of securities markets in Europe, attempts by banks to strengthen their balance sheets and the return of emerging market names. Concerns about increases in interest rates induced some shift by international investors to floating rate assets. Nonetheless, their appetite for higher yields and riskier credit structures strengthened. The US dollar continued to be the main currency of issuance, but it lost further ground to euro-denominated securities.

The global wave of corporate restructuring also led to a rebound in announcements of syndicated loan facilities in the second quarter of 1999. This followed a quarter for which the detailed BIS international banking statistics showed a recovery in the stock of international bank credit outstanding, after a contraction in the final quarter of 1998. However, this first-quarter recovery masked contrasting developments. There was, on the one hand, a retrenchment of Japanese banks from the international interbank market, combined with a further reduction in banks' exposure to emerging markets and the disappearance of the need for interbank lines to support foreign exchange business between euro area legacy currencies. On the other hand, activity was supported by cross-border trading and investment in securities, especially within Europe. A catching-up of business immediately after the introduction of the single currency, following a reluctance by banks to initiate new transactions in legacy currencies before the transition, was another supportive influence.

In the area of derivatives, exchange-traded business rose only slightly in the second quarter, but the proliferation of online dealing systems began to have significant repercussions on market activity and structure. Such channels may improve the efficiency and transparency of markets, but they are likely to increase their fragmentation. Moreover, their rapid expansion is raising a number of questions regarding surveillance and jurisdictional authority.