The global financial markets are dangerously stretched and may unwind with shock force as liquidity dries up, the Bank of International Settlements has warned.
Guy Debelle, head of the BIS’s market committee, said investors have become far too complacent, wrongly believing that central banks can protect them, many staking bets that are bound to “blow up” as the first sign of stress.
In a speech in Sydney, Mr Debelle said: “The sell-off, particularly in fixed income, could be relatively violent when it comes. There are a number of investors buying assets on the presumption of a level of liquidity which is not there. This is not evident when positions are being put on, but will become readily apparent when investors attempt to exit their positions.
“The exits tend to get jammed unexpectedly and rapidly.”
The BIS warned earlier this summer that the world economy is in many respects more vulnerable to a financial crisis than it was in 2007. Debt ratios are now far higher, and emerging markets have also been drawn into the fire over the last five years. The world as whole has never been more leveraged.
Debt ratios in the developed economies have risen by 20 percentage points to 275pc of GDP since the Lehman Brothers crash.
The new twist is that emerging markets have also been on a debt spree, partly as a spill-over from quantitative easing in the West. This has caused a flood of dollar liquidity into these countries that they have struggled to control. It has pushed up their debt ratios by 20 percentage points to 175pc, and much of the borrowing has been at an average real rate of 1pc that is unlikely to last.
Mr Debelle said the markets may at any time start to question whether the global authorities have matters under control, or whether their pledge to hold down rates through forward guidance can be believed. “I find it somewhat surprising that the market is willing to accept the central banks at their word, and not think so much for themselves,” he said
The biggest worry is a precipitous sell-off in the bond markets once the US Federal Reserve and the other major central banks begin to tighten in earnest. Mr Debelle cited the US bond crash in 1994, but warned that it could be even more violent this time with a “fair chance that volatility will feed on itself”.
Full article: BIS warns on ‘violent’ reversal of global markets (The Telegraph)