Rational and Behavioural Drivers of Financial Markets: the case of ‘search for yield’

Silvia Pepino.

Rational and behavioural factors can coexist in financial markets. The ‘search for yield’ (or ‘reach for yield’) observed in financial markets in recent years is a striking manifestation of the interaction of rational and behavioural factors. During an extended period of low interest rates and volatility, market participants have displayed a tendency to seek higher returns by investing in securities that carry higher credit, liquidity or duration risk. This tendency to search for yield appears to have been motivated by a mix of rational fundamental considerations, business and regulatory constraints, and behavioural biases.

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Why has world trade been so weak in recent years?

Katie Stratford.

Before the crisis world trade tended to grow around twice as quickly as world GDP, but since 2012 trade growth has simply matched that of GDP. So what explains this weakness? Contrary to some other economists, this post finds no evidence that factors such as slowing growth of supply chains or the expenditure split of demand can explain the weakness relative to GDP. Instead, it is due to the changing composition of global activity: over time a greater share of world activity has been accounted for by countries whose imports grow more slowly relative to GDP. These trends are likely to continue, such that world trade is likely to grow more slowly relative to GDP than in the past.

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Does oil drive financial market measures of inflation expectations?

David Elliott, Chris Jackson, Marek Raczko and Matt Roberts-Sklar.

Oil prices have fallen by more than 50% since mid-2014. For much of this period, financial market measures of both short-term and longer-term inflation expectations appear to have mirrored moves in oil prices, particularly in the US and euro area. But how strong is the relationship between oil prices and financial market inflation expectations, and what should we make of it?

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Will there really be a pensions spending spree?

Philip Bunn and Alice Pugh

“UK prepares for pensions spending spree” “House prices set to soar by 30 per cent as savers raid pension funds” These were some of the headlines which followed the pension reforms announced by the UK government in the 2014 and 2015 Budgets. But how much truth do they contain? In contrast to some of the headlines, results from a household survey commissioned by the Bank suggest that greater pension freedom will have only a small impact on household spending. And – although a number households would like to invest funds withdrawn from their pension in property – only a subset of these are likely to be able to afford to do so, and some may have bought property even without the reforms.

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Is starting a new market like opening a nightclub?

Arzu Uluc.

Property derivatives markets could allow first time buyers to hedge the risk of price rises whilst they save for a deposit and help prevent prices moving away from underlying fundamentals. But despite this, property derivatives trading is still at a nascent stage. I attribute this to the lack of an appropriate underlying index, a thin secondary market and investor unfamiliarity. But as Shiller (2008) says, this will change over time: “Starting a new market is like opening a nightclub. Lots of people will want to come if lots of people are there. But, if few people are there, few people want to come. Somehow, nightclubs do get started. So too, do real estate futures markets, but it will take time.”

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Financial inclusion and central banks

David Bholat, Julia Kowalski and Simon Milward.

Financial inclusion means every adult having access to fair and affordable savings, transactional banking, credit and insurance. It also requires consumers of financial services to be literate around their use. Whilst this sounds unobjectionably positive, expanding access to financial products can create new risks for financial institutions, financial stability and the financially excluded themselves. Policymakers around the world are grappling with how to balance financial stability with the broader goal of financial inclusion, and have responded in different ways. We believe central banks both in developed and developing countries can play a valuable role in promoting financial inclusion and that they need to consider financial inclusion if they are to promote the good of all the people they serve.

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How important are households’ expectations for spending?

Phil Bunn, Lizzie Drapper, Alice Pugh and Jeremy Rowe.

If the car you’re thinking of buying may be £500 cheaper in six months’ time, why not wait until then to buy it? This kind of thinking is one reason why falling prices trouble central bankers. The spectre of deflation is especially dangerous when households keep delaying their spending in expectation of further price falls. With the economy experiencing close to zero inflation, households may have adjusted their expectations of future prices. But how important are these expectations in influencing household spending? Using a rich household survey dataset we find that while there is some evidence that lower inflation expectations lead to lower spending, income expectations (reassuringly) also play an important role, and they have picked up recently.
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