Fernando V. Cerezetti and Luis Antonio Barron G. Vicente
A vestigial structure is an anatomical feature that no longer seems to have a purpose in the current form of an organism. Goosebumps, for instance, are considered to be a vestigial protection reflex in humans. Default funds, a pool of financial resources formed of clearing member (CM) contributions that can be tapped in a default event, are a ubiquitous part of central counterparty (CCP) safeguard structures. Their history is intertwined with the history of clearinghouses, dating back to a time when the financial sector resembled a Gentlemen’s Club. Here we would like to address the following – perhaps impertinent – question: are current mutualisation processes in CCPs a historical vestige, like goosebumps, or do they still hold an important risk reducing role?
Frank Eich and Jumana Saleheen.
Despite the fact that the financial crisis erupted nearly a decade ago, its legacy is still being felt today. Disappointingly weak growth and low interest rates are arguably part of that legacy (though other developments also matter), and policy makers are increasingly worried that these are no longer temporary phenomena but instead have become permanent features. This blog assesses what a prolonged period of weak growth and low interest rates (sometimes also referred to by “secular stagnation” or “low for long”) might mean for the viability of defined-benefit (DB) occupational pension schemes in the UK and what financial stability risks might arise as a result of a changing business environment.
Julia Giese and Matt Roberts-Sklar.
Government bond yields rose sharply in the UK in October 2016, following increased concerns about ‘hard Brexit’, and in the US since the presidential election in early November 2016. This chart puts these increases into historical perspective: moves in 10-year UK gilts and 10-year US Treasuries were of a similar magnitude to the 2013 US ‘taper tantrum’, the 2015 German ‘bund tantrum’, as well as in the so-called ‘bond massacre’ during the US 1994 tightening cycle.
Empirical identification of the effects of monetary policy requires isolating exogenous shifts in the policy instrument that are distinct from the systematic response of the central bank to actual or foreseen changes in the economic outlook. Because the same tools are used to both induce changes in the economy, and to react to them, distinguishing between cause and effect is a far from trivial matter. One popular way is to use surprises in financial markets to proxy for the shock. In a recent paper, we argue that markets are not able to distinguish the shocks from the systematic component of policy if their forecasts do not align with those of the central bank. We thus develop a new measure of monetary shocks, based on market surprises but free of anticipatory effects and unpredictable by past information.
Yuliya Baranova, Carsten Jung and Joseph Noss.
There has been a recent increase in awareness of investors that limiting emissions to prevent climate change might leave a substantial proportion of the world’s carbon reserves unusable, and that this could lead to revaluations across a range of financial assets. If risks are left unaddressed, this could result in large losses for some investors. But is this adjustment in financial market prices likely to be abrupt? And – even if it is – is it likely to pose risks to financial stability? We argue that the answer to both these questions could be yes: financial valuations can move sharply even if the transition to sustainable energy were smooth. And exposures are sufficiently large to warrant attention from both investors and policymakers.
In a previous post I showed that bond and equity returns are negatively correlated, having been positively correlated for most of the 18th-20th centuries. The time series was long (three centuries) and the chart was just for the UK, prompting two very reasonable questions: 1) does your story hold for countries other than the UK? and 2) what’s happened to this correlation recently?
The 1866 collapse of Overend Gurney sparked widespread panic as investors flocked to banks and other institutions demanding their money back. Failure to provide substantial liquidity threatened to bring down the entire financial system. The Governors of the Bank of England asked the Chancellor to relax the constraints of the 1844 Bank Charter Act, by granting an indemnity to allow the issue of unbacked currency. The Chancellor’s reply, and the policy response it initiated, would save the day, and go down in central banking history as pivotal in the foundation of the “lender of last resort”, a function which has been fundamental to central banking practice ever since.
Huaxiang Huang and Ryland Thomas.
The financial crisis of 1847 has often been dubbed “The trial of the Bank Charter Act of 1844 (Morgan (1952)). The Act sought to remedy the errors of crises past by trying to prevent the overissue of banknotes that many had felt was the major cause of previous crises in 1825 and 1837. The Act gave the Bank of England an effective monopoly in the issue of new bank notes and those additional notes had to be backed one for one with gold. But this had a crucial unintended consequence: it made it difficult for the Bank to act as a lender of last resort. When the crisis struck, the limits imposed by the Act effectively had to be suspended.
Equity prices reflect the market value of public companies, making them an important indicator of the economy. In practice, stocks by firms listed on the local stock exchange serve as the ‘domestic’ equity benchmark but this might be misleading as an indicator of the national economy: stock markets track the performance of individual firms, including their international business. This makes it particularly challenging to extract a signal for the UK economy from UK equity prices, as the universe of UK-listed firms tends to be very global – for instance, around 2/3 of sales represented on the FTSE All-Share are generated abroad. So for a better read of the UK economy, I’ll look at a subset of more UK-focused stocks and other more domestically-focused UK equity indices.
FX assets are traded continuously across the globe. The majority of GBP/USD trades, however, are executed during typical trading hours in London and New York (NY). Saravelos and Grover (2016) find that: (i) FX moves during these hours are most highly correlated to the overall daily move; and (ii) there is statistically significant periodicity where GBP tends to depreciate in the London morning and appreciate in the NY afternoon against the US dollar.