Category Archives: Financial Markets

The impact of Brexit-related shocks on global asset prices

Marek Raczko, Mo Wazzi and Wen Yan

Economists view the United Kingdom as a small-open economy. In economists’ jargon it means that the UK is susceptible to foreign shocks, but that UK shocks do not influence other countries. This definitely was not the case in 2016. The result of the EU referendum, even though it was a UK-specific policy event, had a global impact. Our analysis shows that the Brexit vote not only had a significant impact on UK bond and equity markets, but also spilled over significantly to other advanced economies. Moreover, this approach suggests that the initial Brexit-shock has only partially reversed and still remains a drag on global bond yields and equity prices, though there are wide error bands around that conclusion.

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Filed under Financial Markets, International Economics, Monetary Policy, New Methodologies

Green investment for busy people: retail investors need help to navigate towards the 2°C climate goal

Misa Tanaka

In 2015, the global leaders gathered in Paris acknowledged that climate change represents an urgent and potentially irreversible threat to human societies and the planet, and agreed to work together to limit global warming well below 2°C. Achieving this goal requires global investment to shift away from fossil fuel extraction and power generation towards developing low-carbon energy sources and increasing energy efficiency in the coming years. Retail investors could play a big part in this process if more ‘green’ financial products are marketed on online investment platforms that make it easy for people to understand, assess and compare the climate-related risks in alternative products.

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Filed under Financial Markets, Financial Stability

Of Goosebumps and CCP default funds

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?

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Filed under Financial Markets, Financial Stability, Market Infrastructure

Low for long: what does this mean for defined-benefit pensions in the UK?

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.

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Filed under Banking, Financial Markets, Macroeconomics, New Methodologies

Bitesize: Tantrums, massacres and bond market reversals

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.

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Filed under Bitesize, Financial Markets

The surprise in monetary surprises: a tale of two shocks

Silvia Miranda-Agrippino.

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.

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Filed under Financial Markets, Macroeconomics, Monetary Policy

The tip of the iceberg: the implications of climate change on financial markets

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.

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Filed under Financial Markets, Financial Stability, International Economics

Bitesize: More on the bond-equity correlation

Matt Roberts-Sklar.

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?

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Unto us a lender of last resort is born: Overend Gurney goes bust in 1866

John Lewis.

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.

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Filed under Banking, Economic History, Financial Markets, Financial Stability

The ghost of crises past, present and future: The Bank Charter Act goes on trial in 1847

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.

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Filed under Banking, Economic History, Financial Markets, Financial Stability