Don't be fooled by market calmness, warns Bank for International Settlements

Chris Papadopoullos
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ICAP Brokers Continue To Trade During Financial Turmoil
Markets are unlikely to remain calm for long, BIS chief economist Claudio Borio said (Source: Getty)

Financial markets still face a high level of vulnerability despite calming over recent months, the Bank for International Settlements (BIS) warned today.

The central bank watchdog said bank credit ratings have deteriorated further since 2010 in major advanced economies. BIS chief economist Claudio Borio said the fact bank shares traded at a discount to book values were a clear sign of “mistrust and scepticism”.

In the Eurozone especially, banks still have a high number of bad loans and balance sheet repair needs to pursued, he said.

Borio also pointed to low interest rates on government as a sign markets were not expecting central bank policy rates to policy rates to rise quickly in the US. He also said a third of government debt in the Eurozone had a negative interest rate – a new peak.

“Under such extraordinary conditions, it is not surprising that markets remain unusually sensitive to central banks’ every word and deed. Just think of the market gyrations following the ECB's [European Central Bank] decision to ease even further, but to an extent that fell short of market expectations,” Borio said in his introductory remarks to the BIS quarterly review.

“Against this backdrop, it is hard to imagine how the calm could be anything but uneasy.”

“There is a clear tension between the markets’ behaviour and underlying economic conditions. At some point, it will have to be resolved. Markets can remain calm for much longer than we think. Until they no longer can.”

The BIS also gave its regular warning about dollar debt in emerging markets. When a firm or household borrows in a foreign currency, it becomes vulnerable to a currency ‘mismatch’ where exchange rates can raise the value of its debt compared to its revenues or income. This is expected to weigh on emerging markets as the US Federal Reserve raises interest rates, but many economists have played down the probability of a full-blown crisis, arguing that the country’s involved have made numerous financial reforms since earlier crises, such as the 1997-8 emerging market debt crisis.

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