- Unprecedented stimulus seen causing price anomalies in assets
- BIS calls on governments to cut reliance on monetary policy
Easy-money policies and unprecedented monetary stimulus have started to backfire in global financial markets.
That’s the opinion of the Bank for International Settlements. It says that historically low interest rates and bond-buying programs -- which have sent yields below zero on more than $8 trillion of government bonds, a record amount -- are causing anomalies in asset values. One example is that small price differences in related securities or assets, which banks traditionally eliminated through arbitrage, are persisting more often.
“Monetary policy is running out of room for maneuver,” said Hyun Song Shin, head of research at the BIS, in an interview. “It is not clear how much further stimulus of the real economy can be achieved using monetary-policy tools alone without inviting unwanted distortions.”
The BIS on Sunday called on governments to reduce their reliance on extraordinary monetary policy for spurring economic growth. Instead, they should redouble efforts on structural and financial reforms, it said. The stimulus produced by the world’s monetary authorities will approach the limits of its effectiveness, according to the BIS, which was formed in 1930 and acts as the central bank for many of those institutions.
With the cost of money so close to zero, the profitability and resilience of banks has been sapped, impairing their ability to lend to the wider economy and make markets for securities, the Basel, Switzerland-based institution said in its 86th annual review. When banks choose not to hold as many securities, that reduces depth and liquidity in bond and currency markets, threatening to disrupt their smooth functioning.
Lenders across Europe from Deutsche Bank AG to Societe Generale SA are struggling to increase revenue as the European Central Bank pushes interest rates below zero, regulators demand bigger capital buffers and market volatility spooks investors, according to their financial reports last month. Intesa Sanpaolo SpA, Italy’s second-largest bank, said in May its first-quarter profit dropped 24 percent due to such reasons.
“It’s far better for banks and broker-dealers to have a strong capital base because it allows them to lend more in support of the real economy and on better terms,” the BIS’s Shin said. “It allows them to make markets in a robust way.”
In the foreign-exchange market, erosion of banks’ ability to take trade risk manifested itself in the widening of cross-currency basis, the BIS said in its review of the fiscal year ended March 31, published on Sunday.
Under the theory of so-called covered-interest parity, interest rates implied by currency trading should be consistent with market interest rates. Yet, current implied dollar rates from currency swaps are above Libor. This means that borrowers in dollars through the currency swap market are paying more than the rate available in the open market.
While such anomalies may not be directly caused by low interest rates, they persist partly because fewer banks are willing to “arbitrage it away,” as this would involve them using their own capital to take the other side of the trades, according to the BIS.
Low interest rates have also sent investors into riskier assets to maintain yields, and that may lead to bigger price swings, the BIS said.
“Unease about such valuations, coupled with concerns about the global outlook for growth, resulted in recurring sell-offs and bouts of volatility,” the BIS said in the report. “Markets appeared vulnerable to a sharp reversal of high valuations.”
Unprecedented low yields may distort financial and real economic decisions more generally, for instance by encouraging unproductive firms to maintain capacity or by inflating asset prices, thereby weakening productivity. And they may encourage further debt build-up, which could make it harder for the economy to withstand higher rates, the bank said.