A Cheat Sheet on the Deglobalization of the Financial World
From Brexit and rising polarization in Europe to the protectionist rhetoric of President-elect Donald Trump, this year's played host to a series of political ruptures that threaten a breakdown in the existing internationalist order.
Compounded by dynamics that include money-market reforms and banks' rising regulatory costs, that's helping to fan fears that financial markets are poised to enter an era of deglobalization, mirroring the slowdown in global trade volumes.
From banking credit to bond-market flows to emerging-market capital trends, we present a bevy of charts to sketch the current landscape of financial globalization.
First, here's a bullish case for financial markets: the total volume of foreign debt issued by non-bank institutions has staged a massive expansion over the past decade, underscoring the growing hospitality of fixed-income markets to foreign issuers, and the rising demand for hard-currency borrowing to help finance cross-border corporate activities. International debt securities — issued either in another country or domestically but in a foreign currency — have expanded despite the financial crisis.
But the nature of financial intermediation has shifted sharply away from bank funding to bond markets. Since the crisis, outstanding U.S. dollar credit to non-bank borrowers outside the U.S. has expanded from about $6 trillion to $10 trillion, according to the Bank for International Settlements, underscoring how dollar debt securities have proliferated while bank credit volumes have staged a retreat.
Prior to the crash, banks tapped U.S. funding lines to extend credit to non-U.S. borrowers. Now, low interest rates from the Federal Reserve and a supply of high-yielding bonds from non-U.S. issuers have served to shift the balance of credit transmission from global banks to bond investors. International bank transactions (including interbank exposures and offshore debt issued by financial institutions) have declined since the financial crisis, as lenders derisked their balance sheets. The diminished demand for trade credit also reflects real-world deglobalization, as import-export volumes fell as a proportion of global output.
The bond-market trend has been particularly evident in emerging markets. This year, emerging sovereign and corporate bond issuance denominated in dollars is poised to break records — while flows into local-currency bond funds have been relatively weak — driven by overseas demand for dollar bonds that offer positive inflation-adjusted yields and an increase in sovereign supply to finance deficits. Issuers have sold over $416 billion in dollar debt year-to-date, outpacing the previous full-year record of $411 billion in 2014, according to Bloomberg data.
Cautious capital flows
While the globalization of financial flows in dollars has risen, local currency markets in developing countries have taken a hit. Net capital flows to emerging markets, excluding China, are incredibly weak; the external financing environment for emerging markets has rarely, over the last 30 years, been this weak.
Still, as with the boom in dollar-denominated issuance, by other metrics emerging markets are more globalized than ever before. Emerging market and U.S. interest rates at the long-end of the yield curve are more correlated than ever, as are correlations between China and equity and currency markets in the rest of Asia, underscoring the growth of south-south flows.
A dollar crunch
Increasing integration of financial markets comes with two large costs, in particular: the challenge to control domestic credit conditions, and the financial tightening triggered by the strengthening of the dollar. Historically, a strong greenback has been associated with a sharp contraction in portfolio flows and an increase in the cost of servicing dollar-debt. Now, analysts warn of a looming dollar crunch in Asia that will increase the premium for banks and companies when they assume dollar liabilities; a development that may moderate the pace of outbound exposures.
A strong dollar, bank deleveraging and money-market reforms have also conspired to sharply increase the cost of hedging foreign-exchange risk of dollar transactions for investors in yen and euros. That's a challenge for investors seeking cheap funding for trades, and a potential barrier for growth in trade and financial transactions.
Taking stock: cross-border financial claims and liabilities have risen since the crisis, but have likely slowed down in recent years. At the same time, the world has become more dollarized than ever and more reliant on bond markets, rather than banks.
"While globalization in financial flows has clearly slowed, it is premature to proclaim that financial deglobalization is at hand," analysts at Deutsche Bank AG, led by Peter Hooper, concluded in a report that addressed this subject last week.
Take the International Monetary Fund's Coordinated Portfolio Investment Survey, which captures holdings of cross-border equity and debt securities in participating countries, providing a more consolidated overview of international exposures than can be typically gleaned from balance-of-payments statistics. The IMF data show total cross-border holdings — a blunt proxy for financial globalization — have grown since the crisis, but edged slightly lower between 2013 and 2015.
Savings glut, revisited
A big driver of international financial integration in recent years — and, by extension, a big reason why it's unlikely to grind to a halt without a global trade war — is the growth of domestic savings, reflected in the swelling current-account surpluses of Europe, Japan and China, which tripled between 2011 and 2015 to more than $800 billion, according to the IMF.
The global saving glut is intensifying: HSBC Holdings Plc calculates that this year global imbalances will be close to 2007's record highs, a development that, combined with low rates in Europe and Japan, will continue to fuel net demand for financial assets abroad. The U.S. corporate-bond market is a notable beneficiary of this outbound trend.
Watch the yuan
The attitude of emerging-market policy makers to greater financial liberalization will be key in driving the next stage of global entanglement. China is, therefore, the elephant in the room. Beijing wishes to promote the global use of the yuan for trade and financial transactions, and permit two-way capital flows.
But it faces a challenging balancing act, amid capital outflows and yuan-depreciation expectations. Outflows since the summer have ticked up since this year's low of $37.5 billion in February, rising to $69 billion in October, slightly up from $67 billion in September, according to Bloomberg Intelligence.
How China reconciles its bid to stabilize its economy while making good on its medium-term goal to liberalize will reshape the landscape for the world's financial system for years to come.