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There are signs of “increased risk taking” in global financial markets and “some asset prices look stretched”, the Bank of England warns this morning
In its latest Financial Stability Report, just released, the BoE flags up that asset prices have risen sharply in the last six months, with major equity indices up around 15% on average and corporate bond spreads tightening over the same period.
This increase in risk-taking behaviour creates the danger of “a sharp correction in asset valuations”, the Bank warns, if investors re-evaluate the prospects for growth or inflation, and therefore interest rates.
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In a section titled “Increased risk-taking in global financial markets”, theFinancial Policy Committee (FPC) say:
Risky asset prices have continued to increase, and in some markets asset valuations appear elevated relative to historical norms. This partly reflects the improved economic outlook, but may also reflect a ‘search for yield’ in a low interest rate environment, and higher risk-taking.
The proportion of corporate bonds issued that are high-yield is currently at its highest level in the past decade, and there is evidence of loosening underwriting standards, especially in leveraged loan markets. This could increase potential losses in a future stress, and highly leveraged firms have also been shown to amplify downturns in the real economy.
Bank of England
(@bankofengland)Our latest #FinancialStabilityReport shows what measures we are taking to ensure the financial system remains strong. https://t.co/swIUxHtFNW pic.twitter.com/qbjbGoWeeg
The warning comes as both US and European stock markets are at record highs (although the UK market is still below its pre-pandemic levels).
Michael Batnick
(@michaelbatnick)The S&P 500 is now up 100% from its March 2020 lows. pic.twitter.com/3CGWpmqwNw
The report warns that a correction in asset prices would hurt UK businesses and households, if it led to a rise in interest rates which pushed up borrowing costs:
Sharp decreases in asset prices can amplify economic shocks by impairing businesses’ ability to raise finance, primarily through increasing the cost of bond and equity issuance.
Additionally a sharp correction can directly affect the financial system, for example from banks taking losses on assets held in trading portfolios or by reducing the value of collateral securing existing loans, and by creating sharp increases in the demand for liquidity.
There are several possible triggers for such a correction. Market participants could reassess their outlook for growth should, for example, economic data disappoint. Participants could also adjust their assessment of prospects for inflation and therefore the future path of interest rates. Market intelligence suggests this possibility is high among investor concerns. Should such an adjustment take place, the resulting tightening in financial conditions could also exacerbate debt vulnerabilities from UK households and businesses
Andy Verity
(@andyverity)In its jargony way, the Bank of England is warning that the corporate bond and leveraged bond markets are looking a bit bubble-like. And we all know what happes to bubbles. /1
More to follow…
Also coming up today
Trade data from China today has beaten forecasts, easing fears of a slowdown. Exports rose by 32.2% year-on-year in June, the easing of lockdown measures and vaccination rollouts lifted demand.
That’s despite a pick-up in Cocid-19 cases in southern China that had caused delays in shipments at some major ports for much of June.
Imports growth also beat expectations, rising 36.7% year-on-year, partly due to high raw material prices, customs data showed on Tuesday.
Economic Daily, China
(@EDNewsChina)#CEIndex China’s total imports and exports expanded 27.1% y-o-y to 18.07 trillion yuan(about 2.79 trillion U.S.dollars)in the first half of 2021,official data showed Tue.This marks an increase of 22.8% from the pre-epidemic level in 2019,the General Administration of Customs said pic.twitter.com/b2sIbjvZP7
Shane Oliver
(@ShaneOliverAMP)China June exports and imports both rose more than exp.
Exports +32%yoy, up from +28% in May with exports to EU accelerating.
Imports +37%yoy, down from +51%. Iron ore imports +83%yoy (down from +105%).
Cutting thro the noise & base effects both are strong
(Goldman Sachs chart) pic.twitter.com/ZS2DODd4vm
The latest US inflation report, for June, will show whether price pressures are still elevated. Annual CPI is forecast to dip to around 4.9%, from May’s 13-year high of 5%.
And JP Morgan and Goldman Sachs will kick off the bank reporting season, with results for the second quarter of the year.
The agenda
- 7am BST: Bank of England financial stability report
- 8.30am BST: Bank of England press conference
- 7am BST: German inflation data for June
- 9am BST: IEA’s monthly oil market report
- 1.30pm BST: US inflation report for June