RETURN to normal interest rates will be fraught with uncertainty, and investors should be careful and cautious to make sure they can withstand any surprises, the Bank of International Settlements (BIS) warned yesterday.
Markets have been surprised by the impending tapering in the US, which will see the Federal Reserve slow the pace of money printing and bond buying as the economy recovers.
The Fed is meeting this week, and after weeks of strong jobs data could announce the start of that process.
The group, often called the central bankers’ central bank, believes poor planning for the return of growth and higher rates could throw the recovery off track.
Such a long period of low rates has never before been seen, leaving BIS fearing markets could become panicky.
As employment recovers in the US and the Fed edges towards tapering, market rates have started to rise in the US and across the developed economies.
And that prompted a rush of investment from emerging markets back to the US and other rich-world economies, potentially creating destabilising flows.
“We also know that they will have to rise eventually. What we don’t know is when this will happen, how disorderly the process might be and even less where those yields will settle in the end. The challenge is, therefore, to be prepared,” said BIS’ Claudio Borio, unveiling the body’s quarterly review.
“For market participants, this means to behave prudently, limiting leverage and avoiding the temptation to assume that markets will remain liquid even under stress, what you may call the illusion of liquidity.”
The deputy head of monetary and economics at BIS said the volatility in markets in recent months should remove any doubt that globalisation in financial markets has been unwound since the crisis.
“Central banks know this and they have adjusted their communication accordingly. But there are limits to how far good communication can steer markets,” he said.