Monday 1 June 2020

Trade tension, geopolitical flux ‘raise systemic risk’

LONDON, July 11, 2019

Heightened trade tensions and greater political uncertainty in Europe and the Middle East have increased systemic risks in financial markets, but they remain moderate overall, Moody's Investors Service said in a new report.

Market liquidity has tightened alongside rising volatility in equity markets and capital inflows generally remain lacklustre across most emerging markets. Elevated private leverage will intensify any damage in the next credit downturn.

"We expect that ongoing trade tensions and political uncertainty will keep equity markets volatile. Equity prices still look elevated on some traditional metrics, but these may understate the impact of structurally lower real interest rates," said Colin Ellis, Moody's managing director for Credit Strategy and co-author of the report.

"Although bond markets have been calmer, the market is pricing in more cuts in the US policy rate by year end than indicated by the Federal Open Market Committee. As such, the resolution of this misalignment could generate bond market volatility."

Equity markets fell sharply in May on increased trade tension before rebounding in the following month on indications of further easing by leading central banks. Equity prices still look elevated on some traditional metrics such as price-to-earning ratios, but these may understate the impact of structurally lower real interest rates.

In contrast, the bond market has been slightly calmer overall, despite some volatility in sovereign bond yields, where long-term government bond yields in higher-rated advanced economies declined further as investors reassessed the economic outlook.

Although the supply of safe assets remains steady, it is increasingly concentrated in US Treasury bonds. The proportion of overall supply of Aaa-rated government bonds is on a par with 2008 levels, despite central bank purchases and a deterioration in sovereign credit quality.

However, the lower number of Aaa-rated issuers and the increase in US Treasury bond issuance means that US Treasuries now account for around 75 per cent of all Aaa-rated government bonds available, up from 50 per cent in 2008. In addition, banks' low profitability constrains their ability to cope with the next downturn. – TradeArabia News Service


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