James Purchase and Nick Constantine.
In 1995, Fischer Black, an economist whose ground-breaking work in financial theory helped revolutionise options trading, confidently stated that “the nominal short rate cannot be negative.” Twenty years later this assumption looks questionable: one quarter of world GDP now comes from countries with negative central bank policy rates. Practitioners have been forced to update their models accordingly, in many cases introducing greater complexity. But this shift is not just academic. Models allowing for a wider distribution of future rates require market participants to hedge against greater uncertainty. We argue that this hedging contributed to the volatility in global rates in early 2015, but that derivatives can also play an important role in facilitating monetary policy transmission at negative rates.
Evangelos Benos & Gary Harper.
Since QE began, banks have had a lot more liquidity to make payments. But some have argued (in a nutshell) that banks are reliant on this extra liquidity to make their CHAPS payments and it would be difficult to remove it from the system. Our analysis shows that banks don’t need a great deal of liquidity to make their payments simply because they recycle such a high proportion of them. In practical terms, banks do not rely on high reserves balances to make their CHAPS payments so unwinding QE shouldn’t have any impact on banks’ ability to do just that. We also briefly go over the potential reasons for this such as the CHAPS throughput rules, the Liquidity Savings Mechanism, and the tiered structure of CHAPS.
CHAPS banks have oodles of liquidity and are not afraid to use it, as quantitative easing has meant banks accumulated unprecedented quantities of reserves. And in this liquidity-abundant world, banks are less likely to be concerned with how well they use tools for liquidity saving in the Bank’s Real-Time Gross Settlement (RTGS) infrastructure. And besides, the timings of liquidity-hungry payments are stubborn. They can’t always be retimed to optimise liquidity usage, and this means that the potential for liquidity savings in RTGS from the Bank’s Liquidity Savings Mechanism (LSM) is limited.
It’s been a while now since high-frequency-trading (HFT) made its debut in the financial market landscape. Initially, little was known about it and regulators and market participants alike were naturally concerned about its potential impact on markets. Nevertheless, over the past few years we have learned quite a bit more about HFT. So what’s the deal with HFT? This short blog post briefly describes the evolution of HFT, summarizes the current understanding of the impact of HFT on market quality and highlights some aspects of HFT activity that are still contentious. Regardless, I believe, the inescapable conclusion that so far emerges is that HFT has mostly had a positive impact on market functioning.
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?
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.”
In June of 1974, a small German bank, Herstatt Bank, failed. While the bank itself was not large, its failure became synonymous with fx settlement risk, and its lessons served as the impetus for work over the subsequent three decades to implement real-time settlement systems now used the world over. Documents from the Bank of England’s Archive shed light on a lesser known aspect of Herstatt’s failure – the chain reaction it caused across financial centres as banks in different countries delayed settling their payments to each other. The lesson for policymakers today to grapple with is: when a bank fails, could we still expect surviving banks to delay making payments, with a potential chain reaction in the payment system?