The macro consequences of dollar shortages and central bank swap lines during the Covid-19 pandemic

Fernando Eguren Martin

Dollar shortages in funding markets outside the United States have been a recurrent feature of the last three major crises, including the turmoil associated with the ongoing Covid-19 pandemic. The Federal Reserve has responded by improving conditions and extending the reach of its network of central bank swap lines, with the aim of channelling US dollars to non-US financial systems. Despite the recurrence of this phenomena, little is known about the macroeconomic consequences of both dollar shortage shocks and central bank swap lines. In this post (and in an underlying Staff Working Paper) I provide some tentative answers.

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Fluttering and falling: banks’ capital requirements for credit valuation adjustment (CVA) risk since 2014

Giulio Malberti and Thom Adcock

The financial crisis exposed banks’ vulnerability to a type of risk associated with derivatives: credit valuation adjustment (CVA) risk. Despite being a major driver of losses – around $43 billion across 10 banks according to one estimate – there had been no capital requirement to cushion banks against these losses. New rules in 2014 changed this.

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Does liquidity spill over in the credit market? The case of CDS and corporate bonds

Robert Czech

Credit default swaps (CDS) have a notoriously bad reputation. Critics refer to CDS as a “global joke” that should be “outlawed”, not at least due to the opaque market structure. Even the Vatican labelled CDS trading as “extremely immoral”. But could there be a brighter side to these swaps? In theory, CDS contracts can reduce risks in financial markets by providing valuable insurance. In a recent paper, I show that CDS also offer another, more subtle benefit: an increase in the liquidity of the underlying bonds.

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Bitesize: 250 years of the bond-equity correlation

Matt Roberts-Sklar.

For most of the 18^th-20^th centuries, government bonds usually behaved like a risky asset. When equity prices fell, bond yields rose, i.e. bond and equity returns were positively correlated (bond prices move inversely to yields). But since the mid-2000s, bond and equity returns have been negatively correlated, i.e. bonds became a hedge for risk. Before this, the last time this correlation was near zero for a prolonged period was the long depression in the late 19^th century.

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No smog without fire: the financial stability risks around carbon-intensive investments

Rhiannon Sowerbutts.

An abrupt transition to a lower-carbon economy might cause disruption in financial markets as the value of energy companies is rapidly reassessed. Last year there was a sea change in attitudes as several funds divested their fossil fuel related assets, equity analysts and rating agencies began to issue warnings about carbon-intensive firms and the Paris Climate Change agreement was hailed as a breakthrough as it made the concept of a carbon budget that would limit future fossil fuel use mainstream. However, analysis of climate related ‘events’ suggests that although energy firms’ equity prices move in the expected direction this movement isn’t statistically significant. This doesn’t mean as global citizens we can relax, either about financial stability or for the future of the planet.

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