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Economic environment
The EU sovereign debt situation continued to affect securities markets, albeit immediate threats due to the deterioration of fiscal or banking sector conditions in various MS appeared to have eased. Uncertainties related to elections and crisis measures in some vulnerable MS, which affected securities markets during 2Q13, continued to be relevant in 3Q13. As the reporting period drew to a close, tensions arose around US budget negotiations, raising market uncertainty over the ability of the US to avert technical default. While the immediate situation was defused by the 17 Oct compromise bill, budget negotiations are set to continue subject to new deadlines in 1Q14, and markets can be expected to remain alert to developments in this area.
Liquidity risk
The liquidity premium required by investors to acquire shares of hedge funds on the secondary market increased to mid-2012 levels, having compressed briefly in March 2013. This may signal renewed caution entering investors’ expectations of hedge funds’ future performance. Factors affecting the liquidity of investment into hedge funds include broader market trends and macro-economic risks.
Market risk
Net inflows into investment funds generally displayed high volatility during 3Q13. This peaked at the beginning of the reporting period, marked by a shift in yield curves in advanced economies as well as a sell-off in Asia. The latter included a decline in stock prices across Asia and the devaluation of some Asian G20 currencies, reflecting asset reallocation across markets. Somewhat improved prospects for the US and some European economies further increased the relative attractiveness of developed markets over EM investments. In particular, US and Western European equity and bond funds experienced higher inflows compared to the previous period. Cumulative net flows into US equity funds turned positive for the first time since mid-2004.
Contagion risk
Correlations of Bunds with other EU 10Y sovereign bonds broadly remained above the – by crisis standards – relatively high levels seen in 2Q13, approaching unity before receding somewhat later in the quarter. The dispersion was driven by the most vulnerable sovereigns. This continued co-movement of EA sovereign yields at levels not seen since end-2010 suggests that expectations regarding EA sovereigns are to a greater extent aligned than during more acute phases of the crisis. Notwithstanding the high sensitivity of the most vulnerable sovereigns, with markets continuing to differentiate across markets, system resilience may have enhanced.
Credit risk
Average maturities of outstanding debt increased in 3Q13 across nearly all sectors except for industrial corporates. Sovereigns that were able to access market-based financing could thus benefit from low interest rates and relatively flat yield curves. Still, some EU sovereigns continued to experience funding constraints, also affecting their ability to expand maturities. The general increase in average maturities of banks may be closely related to deleveraging in this industry: Average maturities of debt outstanding increased while net issuance of short-term debt declined to a greater extent than that of longer-term debt.