In a new BIS paper K. Miyajima provides evidence that unsterilized FX interventions in emerging market economies fail to influence exchange rate forecasts (as published by Consensus Economics) in the direction of the intervention. This supports the intuition of market practitioners that interventions may briefly stem or reverse the market tide, but do not typically have the purpose or power to change the prevailing fundamental trend.
The “reach for yield” bias of institutional investors
‘Reach for yield’ describes regulated investors’ preference for high-risk assets within the confines of a rule-based risk metric (such as credit ratings or VaR). Bo Becker and Victoria Ivashina provide evidence that U.S. insurance companies act on this principle and show that ”conditional on ratings, insurance portfolios are systematically biased toward higher yield bonds”. ‘Reach for yield’ would be a form of regulatory arbitrage, a source of inefficiency, and a reward for “unaccounted risk” of securities and issuers.
Measuring diversification and downside risk
Deutsche Bank’s Handbook of Portfolio Construction gives a great introduction to two important principles for diversification and risk management of portfolios. First, tail dependence is a better guide to diversification than correlation when it really matters, i.e. in market turmoil. Second, conditional Value-at-Risk concepts (CVaR) estimates average losses one may sustain in an extreme event, and hence should be more representative for true downside risk than standard VaR. Backtests suggest that portfolio construction based on these and other risk measures produces signficant investor value.
China’s commodity financing deals
Chinese commodity financing deals exemplify how regulation and circumvention can distort more than one major market. These transactions have been a means for circumventing capital controls and facilitated short USD-CNY carry trades. Thereby they generated capital inflows into China, and distorted demand for physical metals (particularly copper) vis-a-vis futures. As China’s State Administration of Foreign Exchange (SAFE) has issued new regulation to curb these transactions, rapid unwinding might cause reverse distortions.
Quantitative easing and “VaR shocks”
Securities held by VaR (Value-at-Risk)-sensitive institutional investors, such as banks, are prone to escalatory selling pressure after an initial shock, in particular if they make up a substantial portion of the portfolio. Nikolaos Panigirtzoglou underscores that the Japanese government bond market has already demonstrated its proclivity to such ‘VaR shocks’. Also on a global scale government bond yields may overtime become more vulnerable, as one of the unintended consequences of quantitative easing.
The effectiveness of non-conventional monetary policy
The latest IMF publications on non-conventional monetary policies affirm their effectiveness. This seems to hold true for all major forms, i.e. government bond purchases, forward guidance, and private asset purchases. However, bond purchases are likely to yield diminishing effects going forward. Their initial stimulus seems to owe much to the signalling of commitment and the repair of broken markets. Also, the economic impact seems to have a time limit. Meanwhile additional credible yield compression becomes ever more difficult as the zero boundary is drawing closer and central banks would struggle to extend commitments to ever longer durations.
Historical precursor of Abenomics
Warwick professor Nicolas Crafts notes that the UK’s exit from recession and deflation in 1930s has similarities to Japan’s current expansionary policy. At the time the UK managed recovery and reflation through very low rates and initial currency devaluation. Crafts argues that such strategies may require abandoning inflation-targeting independent central banks.
China’s highly leveraged state-owned corporates
Morgan Stanley’s Viktor Hjort, Nishant Sood, and Gaurav Singhal show that financial leverage of China’s corporates has reached record highs, particularly for state-owned enterprises (SOEs). Increased debt financing reflects easy credit conditions and has partly served to cover funding gaps. In case of an economic downturn, consequences for credit quality would probably be more severe now than back in 2009.
Improving the information value of dividend yields
Marco Dion, Viquar Shaikh and colleagues at J.P. Morgan Cazenove illustrate how the information value of equity dividend yield can be enhanced. Their measure of “shareholder yield” integrates dividends with other forms of cash returns, i.e. share buybacks and debt redemption. They present evidence that for U.S. and European stocks the enhanced measures creates alpha for systematic trading styles.
Nomura research on rising China crisis risk
According to Nomura’s Zhiwei Zhang and Wendy Chen, “China is displaying the same three symptoms that Japan, the US and parts of Europe all showed before suffering financial crises: a rapid build-up of leverage, elevated property prices and a decline in potential growth…the most vulnerable areas are local government financing vehicles, property developers, trust companies and credit guarantee companies.”
