BASEL, Switzerland (HedgeWorld.com)–The Bank for International Settlements’ June 2006 Quarterly Review has underlined what it terms a “retreat from risky assets”, which it says began to take hold in early May. The authors noted that this followed a general rise in yields on government bonds. Bond prices had continued to fall up to mid-May, a reflection on the one hand of investor concerns about higher inflation, but also an indication of expectations that the global economy could continue to grow at a steady pace.
The sharp downturn in the exchange rate of the dollar and the continued tightening of spreads on low grade corporate and emerging market debt did little to dent investor enthusiasm for equities and commodities. These asset classes continued to appreciate until mid-May, when the rally came to a sudden end on concerns that the broad-based rise had been overdone.
Since mid-May, emerging equities markets have suffered the sharpest downturn, but other equities markets too have seen a sharp sell off, notes the report. Investors have rushed to rebalance portfolios in favor of government bonds. According to the BIS review, this flight to quality is a reflection of higher risk aversion among investors rather than representing a general reassessment of fundamentals.
World-wide, international debt issuance increased by a gross 24% to $1.2 trillion in the first quarter of 2006. On a net basis, eliminating debt that had matured during the period, issuance rose 9% to $622 billion. The research notes that these are both historic peaks, suggesting a favorable financial environment and improving access for many borrowers to international credit markets. US entities and corporate issuers were the main contributors to the growth, while issues in Japan for the quarter exceeded total issuance for the six previous quarters combined. Net borrowing in the euro area also grew, but at a far slower pace.
In emerging markets, borrowing increased by 19% to just under $60 billion, and net borrowing rose by 33% to 42 billion, both record levels. The report attributes these increases to a combination of improved fundamentals, but also to international investors broadening their horizons in the search for yield.
Trading on international derivatives exchanges also accelerated in the first quarter. Notional amounts of interest rate, equity index and exchange rate contracts increased by around 25% to 429 trillion in the period. Stock index contracts rose 11% to a record $43 trillion, while growth in interest rate contracts was particularly marked, especially in US$ and yen contracts. Trading in energy and non-precious metals derivatives increased sharply, with volumes remaining high but stable in precious metals derivative contracts.
With respect to credit default swaps (CDS), data is only available to December 2005. The notional amount of CDS outstanding increased by about one third, or $14 trillion, in the last half of last year. However, the increase also highlighted some transparency problems in this market, with occasional shortages in deliverable debt and trade confirmation backlogs being indicated as particular problem areas. The research noted that an examination of CDS statistics by counterparty indicates that this is largely an interbank market, with limited purchases of CDS by insurance companies looking to take on credit risk.
In the international banking market, the review notes increased yen borrowing from the UK and from offshore centers, a trend which began in mid-2004 and continued through to the end of 2005. This, according to the review, suggests an increase in yen-funded carry trades during the period. There has also been an increase of international lending to emerging markets, particularly in Eastern Europe and Latin America, with conditions for borrowers improving as a result.
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