16 September 2024

BIS Quarterly Review, September 2024

The BIS Quarterly Review includes analysis on recent developments in financial markets, life insurance, global alignment and trade, capital flows to EMEs and global banking statistics.

De-risking began to stir financial markets over the review period but the stresses proved short-lived.¹ While markets experienced sharp bouts of volatility, investors quickly reverted to the risk-on mode that had prevailed for several months. Financial conditions thus remained loose. Yet the turbulence illustrates how markets have become vulnerable to swift mood shifts, especially related to current growth jitters.

Although de-risking pressures had been brewing since the beginning of July, the cusp of the stress occurred at the beginning of August. In July, markets had already experienced some corrections, especially in tech stocks that had previously surged in valuations. Volatility had picked up, with early signs of deleveraging and a reversal of trades predicated on past trends and low volatility. In early August, following Federal Reserve and Bank of Japan policy meetings perceived as somewhat hawkish, markets overreacted to a disappointing US labour market release. While the equity market correction began in the United States on Friday 2 August, Japan emerged as a locus of turbulence the following Monday. Leveraged positions, above all carry trades, came under pressure, with the yen appreciating sharply and the stock market selling off. The equity slump and the currency repricing reverberated globally, and the VIX spiked. That said, markets stabilised remarkably quickly and erased losses within days, partly thanks to more benign incoming data and central bank communication. In early September, volatility resurfaced again when negative US macro releases led to another correction in equity markets.

During the August sell-off, currency carry trades unwound amid changing expectations of interest rate paths and heightened volatility. Since carry trades borrow in low interest currencies to invest in higher-yielding ones, the unwinding caused a sharp, if short-lived, appreciation of the funding currencies, predominantly the yen, and a depreciation of the investment currencies, such as the Mexican peso and other emerging market economy (EME) currencies. These fluctuations were large but not outsize compared with past carry trade crashes, and foreign exchange (FX) volatility did not rise nearly as much as that of equity markets. Moreover, even though EMEs were exposed to the unwinding of carry trades and spillovers of the risk-off mood, they withstood the bouts of volatility quite well.

Fixed income markets in major economies mostly reflected shifts in policy expectations and the growth outlook, even amid the turbulence. From July onwards, market participants began reassessing the odds of a soft landing. As signs of an intensification of the slowdown surfaced in early August, government bond yields fell markedly, as investors priced in more aggressive rate cuts. Concerns over a global slowdown led to more internationally synchronised movements across bond markets. This halted the divergence that had sustained US dollar appreciation since 2021.

Credit markets were the least affected by the bouts of volatility and de-risking. Corporate bond spreads did widen across advanced economies, but only marginally, and overall credit conditions remained benign by historical standards. Similarly, bank credit supply terms no longer tightened. Against this background, broad measures of financial conditions loosened. Towards the end of the review period, the risk-on mode was again in full swing but still vulnerable to sudden changes in mood.

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