What is the information content of oil futures curves?

Julian Reynolds

Moves in oil prices have significant implications for the global economic outlook, affecting consumer prices, firm costs and country export revenues. But oil futures contracts tend to give an imperfect steer for the future path of oil prices because, at any given time, futures contracts may be affected by a wide range of fundamental drivers, besides the expected path of future spot prices. This post presents an empirical methodology to determine the so-called ‘information content’ of oil futures curves. I decompose the oil future-to-spot price ratio into structural shocks, which reflect different fundamental drivers of futures prices, in order to identify the extent to which futures prices reflect market information about the outlook for spot prices.

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Bitesize: The pricing of credit risk

Barbara Jankowiak, Natan Misak and Nicholas Vause

Both financial market participants and regulators have suggested that investor risk appetite has declined since the beginning of the year. This post presents some evidence from credit markets consistent with such developments, and offers two possible explanations.

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Swing or amiss: are fund pricing rules good for financial stability?

Benjamin King and Jamie Semark

Open-ended funds (OEFs) offer daily redemptions to investors, often while holding illiquid assets that take longer to sell. There is evidence that this mismatch creates an incentive for investors to redeem ahead of others, which could lead to large redemptions from OEFs and asset price falls. Some research has suggested that ‘swing pricing’ can help to moderate these redemptions, but until now, no-one has considered the impact of its use on the wider economy. In a recent paper, we carry out a financial stability cost-benefit analysis of more widespread and consistent usage of swing pricing by OEFs, finding that enhanced swing pricing could reduce amplification of shocks to corporate bond prices, providing benefits to the financial system and economy.

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Back to the Future IV: challenges for financial stability policy in the next decade

Alina Barnett, Sinem Hacioglu Hoke and Simon Lloyd

Since 2007, macroprudential policymakers have grappled with a broad set of vulnerabilities. While regulators cannot be sure what risks the next decade will feature, they can be sure that the set of issues will continuously evolve. In this post, we explore three timely challenges that financial stability policymakers are likely to face in the coming years, including risks associated with: non-bank financial intermediation, cryptoassets and decentralised finance (DeFi), and climate change. These challenges have been noted by many, and are already stimulating development of macroprudential frameworks. But while some of this development can build on well-grounded principles for financial stability policy, other aspects are likely to come up against three timeless challenges, requiring novel and innovative thinking to overcome.

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Monetary policy transmission during QE times: role of expectations and premia channels

Iryna Kaminska and Haroon Mumtaz

Since 2009, when policy rates reached their effective lower bound, quantitative easing (QE) has become an important instrument of central bank monetary policy. It is aimed to work via long-term yields. The literature confirms that QE helped lower long-term yields. But the yields have two components – expectations and term premia – and open questions remain: does QE reduce yields via expected rates or term premia? And which channel is more efficient in stimulating the economy? In our research paper, we find evidence that QE often worked through signalling and term-premia effects simultaneously. But the two main QE channels are transmitted to financial markets and the real-economy in different ways, and only signalling is found to have ultimately affected inflation significantly.

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Measuring business dynamics in real time

Thibaut Duprey, Artur Kotlicki, Daniel Rigobon and Philip Schnattinger

Just as doctors monitor in real time the vital signs of their hospitalised patients to determine the best course of treatment, economists are turning towards a real-time tracking of economic conditions to inform policy decisions (for example, through proxy for GDP and inflation). In a recent paper, we introduce a new quasi-real time estimation of business opening and closure rates using data from Google Places – the dataset behind the Google Maps service. We find that the lifting of COVID-19 restrictions in Canada coincides with a wave of re-entry of temporarily closed businesses, suggesting that government support may have facilitated the survival of hibernating businesses.

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Debt and investment: what can we learn from SMEs’ investment behaviour during and after the Global Financial Crisis?

Mai Daher and Christiane Kneer

Many UK firms weathered the Covid shock by taking on debt. Small and medium-sized enterprises (SMEs) in particular borrowed at an unprecedented rate and their debt increased by around a quarter since end-2019. But debt that allowed SMEs to survive the pandemic could now hamper the recovery as indebted firms may struggle to invest and grow. Debt on SMEs’ balance sheets could also make firms more vulnerable to future shocks and could amplify downturns if indebted firms reduce investment more following shocks. To understand how investment might evolve, our recent FS paper examines how leverage affected SME investment during and after the Global Financial Crisis (GFC) and discusses potential differences given regulatory and other changes since the GFC.

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Predicting exchange rates

Robert Czech, Pasquale Della Corte, Shiyang Huang and Tianyu Wang

Can investors predict future foreign exchange (FX) rates? Many economists would say that this is an incredibly difficult task, given the weak link between exchange rate fluctuations and the state of an economy – a phenomenon also known as the ‘exchange rate disconnect puzzle’. In a recent paper, we show that some investors in the ‘FX option market’ are indeed able to accurately forecast exchange rate returns, particularly in periods with strong demand for the US dollar. These informed trades primarily take place on days with macroeconomic announcements and in options with higher embedded leverage. We also find that two groups of investors – hedge funds and real money investors – have superior skills in predicting exchange rates.

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An unintended consequence of holding dollar assets

Robert Czech, Shiyang Huang, Dong Lou and Tianyu Wang

During the March 2020 ‘dash for cash’, 10-year gilt yields increased by more than 50 basis points. This huge yield spike was accompanied by the heavy selling of gilts by mutual funds and insurance companies and pension funds (ICPFs). Focusing on the latter group, we argue in a recent paper that ICPFs’ abnormal trading behaviour in this period was partly a result of the dollar’s global dominance: ICPFs invest a large portion of their capital in dollar assets and hedge these exposures through foreign exchange (FX) derivatives. As the dollar appreciated in March 2020, ICPFs sold large quantities of gilts to meet margin calls on their short-dollar derivative positions, contributing to the yield spike in the gilt market.

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Preferred habitat behaviour in the gilt market

Julia Giese, Michael Joyce, Jack Meaning and Jack Worlidge

Every financial market transaction has two parties, each with their own preferences. One channel through which quantitative easing works rests on these differences: preferred habitat investors value certain assets above others for non-pecuniary reasons, beyond risk and return. Central bank asset purchases of the preferred asset create scarcity, which may lead to compensating price adjustment, with spillovers to other assets and the macroeconomy. There is, however, little hard evidence on these investors. In a staff working paper, we use a new granular data set on gilt market holdings and transactions to identify groups of investors with preferred portfolio duration habitats. We present a case study suggesting that the Bank’s purchases appear to have come disproportionately from one group of these investors with a relatively strong preference for specific gilt maturities.

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