Global Financial Stability Fabio Natalucci Deputy Director - - PowerPoint PPT Presentation

Global Financial Stability

Fabio Natalucci

Deputy Director Monetary and Capital Markets Department

International Monetary Fund

July 18, 2018

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5 10 15 20 25 30 Oil (Brent) China equities Commodities S&P 500 Eurostoxx 50 EM equities Topix US corp HY EM sov $ EM corp $ Gold Euro corp HY US corp IG EM govts local Euro corp IG JGBs US T-Bills 2019 YTD 2018Q3 - Q4 Returns by Asset Class (Percent)

Financial Markets Have Recovered from 2018 Losses

Markets sold off in 2018, but have generally recouped their losses so far this year

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Risk Assets Have Reflected the Ebb and Flow of Trade Tensions

2 Relative Equity Performance of Trade-sensitive Firms (Relative to benchmark, index to March 2018)

Trade tensions weighed on equity and credit markets

EM sovereign and Global High Yield Corporate Spreads (Basis points)

Note: 1. US initiated national security investigation into autos; 2. US announced 25% tariff on $50 bn Chinese goods; 3. US implemented 10% tariff on $200 bn of Chinese goods; 4. US tariff on $200 bn of Chinese goods hiked to 25%; 5. June FOMC meeting when policy rate expectations were revised lower; 6. G20 meeting.

70 75 80 85 90 95 100 105 110 115 120 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Euro area auto firms US firms with high China sales China firms with high US sales 1 2 3 4 5 6 250 300 350 400 450 500 550 600 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 EMBIG Global high-yield corporate

EM Capital Flows Have Been Volatile

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Growth and trade concerns have weighed on EM portfolio flows in recent months

EM Portfolio Flows by Investor Type (USD billions; three-month rolling sum)

Bond flows to China have been strong after index inclusion

Index-Inclusion Related Flows to China (RMB billions)

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20 40 60 80 100 120 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Change in foreign holdings of Policy Bank Bonds Change in foreign holdings of Treasury Bonds Stock Connect Northbound equity purchases

MSCI announcement First phase of MSCI inclusion First phase of Global Agg Inclusion

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30 60 90 120 150 2013 2014 2015 2016 2017 2018 2019

Renminbi devaluation U.S. election Taper tantrum

Institutional flows Retail flows

EM Sell-off

Total flows

Market Conditions for Frontier Issuers Remain Favorable

4 Frontier Market Sovereign Issuance: Volume (USD billions)

Issuance is expected to reach new highs in 2019…

Frontier Market Sovereign Issuance: Price (Percent; Basis points)

… on favorable market conditions

5 10 15 20 25 30 35 40 45 2010 11 12 13 14 15 16 17 18 19YTD 19E BB B+ B B- CCC

100 200 300 400 500 600 5 6 7 8 9 10 2014 2015 2016 2017 2018 2019 Interquartile range (right scale) Median yield (left scale)

Financial Conditions Have Eased

5 Financial Conditions Indices (Standard deviations from mean)

Financial conditions have eased in the US and euro area …

United States: Contributions to Financial Conditions (Standard deviations from mean)

… as market interest rates have fallen

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0.0 0.2 0.4 0.6 2016 2017 2018 2019 Interest rates House prices Corporate valuations United States

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0.0 0.2 0.4 0.6 0.8 1.0 2016 2017 2018 2019 April 2019 WEO Tightening United States China Euro area Other emerging market economies

The Inflation Outlook Have Deteriorated

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Market expectations of inflation have declined… … along odds of high inflation.

Market Expectations of Inflation (Percent)

0.0 0.5 1.0 1.5 2.0 2.5 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 US Euro area US Euro area 5-year breakeven 5-year-5-year forward inflation swaps 5 10 15 20 25 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 United States Euro area

Market Implied Probability of High Inflation (Probability of CPI > 3% for 1 year in 5 years, percent)

Investors Expect Monetary Policy Easing

7 Advanced Economy Policy Rates (Percent)

Further monetary policy easing is priced-in for AEs…

Emerging Market Policy Rates

… as well as many EMs

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0.0 0.5 1.0 1.5 2.0 2.5 15 16 17 18 19 20 21 22 United States Euro area Japan 20 United Kingdom

BRA CHL COL MEX PER IND IDN MYS PHL THA HUN POL ROM RUS ZAF

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20 40 60 80 2 4 6 8 10 Current policy rate (percent) Expected 1-year change in policy rate (bps)

Global Bond Yields Have Declined Further

8 Government Bond Yield Curves

Global yields have fallen on expectations of policy easing …

Global Bonds with Negative Yields

… leading to a rise in negative-yielding bonds

5 10 15 20 25 30 2 4 6 8 10 12 14 2015 2016 2017 2018 2019 Market capitalization Share of total global bond market (rhs) ($tn) (%)

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0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2 4 6 8 10 Yield (percent) Maturity (years) 2 4 6 8 10

October 2018 GFSR April 2019 GFSR Latest

Maturity (years)

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0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2 4 6 8 10 Yield (percent) Maturity (years) United States Germany Japan

US Forecast Distribution: Conditional 1-year Ahead Real GDP Growth (Percent)

The tail of the distribution moves to the left when the yield curve is included

US Downside Risks to GDP Growth (Percent)

Downside risk is higher ahead of recessions

Inversion of the Yield Curve Points to Downside Risks to Growth

Note: The slope is measured as the difference between 3-month and 10-year Treasury yields. This slope is used in the estimation instead

• f the financial conditions index.

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2 4 6 1980 1985 1990 1995 2000 2005 2010 2015 0.0 0.1 0.2 0.3

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1 2 3 4 5 Including the slope of the yield curve No financial conditions 5th percentile

Investors Expect Risks to be Contained in the Short-term

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Equity investors believe downside risks are contained… …and market volatility remains compressed

US Equity Skew Index (Standard deviations from historical average)

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1 2 3 4 5 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19

US Equity and Bond Volatility (Standard deviations from historical average)

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1 2 3 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 VIX MOVE

Easy Conditions Are Encouraging Corporate Financial Risk Taking

11 S&P500 Nonfinanical Firms: Debt-Funded Payouts (Percent of assets; annualized)

Debt-funded payouts by US firms have risen further …

US Leveraged Loan Market (USD billions; Debt/EBITDA in multiples)

… and leverage continues to rise

4.0 4.5 5.0 5.5 6.0 6.5 7.0 50 100 150 200 250 300 2003 2005 2007 2009 2011 2013 2015 2017 2019 M&A volume LBO volume Average LBO Debt/EBITDA (rhs) Note: annualized 2019 number based on data till May. 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 0.0 0.3 0.6 0.9 1.2 1.5 2005 2007 2009 2011 2013 2015 2017 2019

High leverage firm Low leverage firm High leverage firm (% of debt, rhs)

An “Unusual” US Monetary Policy Cycle

12 US Financial Conditions Index (FCI) During Tightening Cycles

Financial conditions have eased during the most recent monetary tightening cycle in the US

Note: Based on GFSR FCI from 1995. Pre-1995 FCI is spliced using the Chicago adjusted FCI.

US Financial Conditions Index (FCI) During Easing Cycles

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0.0 0.5 1.0 1.5 2.0 200 400 600 800 1984 1987 1989 1995 2001 2007 Cumulative rate cuts (bps) Financial conditions index 5.7 2019

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0.0 0.5 1.0 1.5 2.0 100 200 300 400 500 1983 1986 1988 1994 1999 2004 2015 Cumulative rate hikes (bps) Financial conditions index

Central Bank Balance Sheet (Percent of GDP)

How much policy space is available?

Unconventional Monetary Policies in the Next Recession?

20 40 60 80 100 120 BOJ PBOC ECB BOE Riskbank Fed 2008 2019

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S&P Index Returns through Tightening Cycles Treasury 10-year Yields through Tightening Cycles

Cycle starts Cycle ends 6 months afterwards

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Where Are We Headed…?

80 90 100 110 120 130 140 150

1983 1986 1988 1994 1999 2004 2015

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1983 1986 1988 1994 1999 2004 2015