Published March 12, 2018
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The recent volatility in global financial markets should not deter top central banks from lifting interest rates or ending years of unprecedented stimulus, the Bank for International Settlements said.
The latest report from the Switzerland-based group said that after such a long period of calm there were bound to be more market wobbles and that trade war worries were making the “delicate task” of trying to normalize policy more complicated.
Nevertheless, the move toward higher interest rates, which started in the United States and is gradually gaining traction elsewhere, should continue.
“Treading the path (of policy normalization) will call for a great deal of skill, judgment and, yes, also a measure of good fortune,” said Claudio Borio, the head of the BIS’ monetary and economic department.
“But policymakers need not fear volatility as such. Along the normalization path, some volatility can be their friend.”
The BIS is an umbrella group for the world’s central banks so its reports are seen as an indicator of the thinking that goes on behind the closed doors of its quarterly meetings.
It dissected the recent market correction which wiped trillions of dollars off the value of global stocks. It put it down to strong U.S. growth and wage inflation data which triggered anxiety about faster interest rate rises.
It added that the rout also showed how much risk investors and traders had taken on in the run-up to the sell-off.
“The market wobble may well not be the last. Financial markets and the global economy are sailing in uncharted waters,” Borio said, referring to coming out of years of near-constant stimulus and record-low interest rates.
BIS staff also looked at the role volatility-focused Exchange Traded Funds, which buy and sell things such as stock volatility futures, played in last month’s turbulence which saw world equities shed 10 percent.
They found some market participants began ‘bidding up’ VIX futures prices as a certain point in the afternoon in anticipation of a usual end-of-day asset ‘rebalancing’ by these types of exchange-traded products (ETP).
“Due to the mechanical nature of the rebalancing, a higher VIX futures price necessitated even greater VIX futures purchases by the ETPs, creating a feedback loop,” the report said.
There was a separate section of the report too which showed the rapid growth of ‘passive funds’ like ETFs that invest in assets tracking the return of a benchmark or an index.
These type of funds now constitute 20 percent of investment fund assets and 43 percent of U.S. equity fund assets it found. Exchange-traded funds are 40 percent of passive fund assets.
A concern is that a further rapid growth in these funds could change how markets react in times of stress, with the potential for more correlated and therefore dramatic moves if they shift on common factors rather than asset-specific ones.
Re-disseminated by The Asian Banker from Reuters