- Research from the Bank of International Settlements highlights two key shifts that have taken place since the GFC in 2008.
- Bond markets are now the primary driver of global credit, not bank loans. And the US dollar is now even more dominant as the vehicle for global debt funding
- The net result is that global markets are “even more tightly linked to US monetary policy”.
The US Federal Reserve’s interest rate announcement this Wednesday night looms large on the economic calendar.
If the Fed is deemed to be more dovish or hawkish than expected, it could spark sharp moves in global markets.
And research this week from the Bank for International Settlements shows why.
BIS analysts Iñaki Aldasoro and Torsten Ehlers explain that after a decade of easy monetary policy by global central banks, the Fed is now firmly entrenched as the key pivot point for the global economy.
They highlighted two key trends which have emerged in the fallout from 2008’s global financial crisis (GFC):
1. Growth in international credit has been driven by debt securities (bonds), rather then bank loans; and
2. The US dollar has become “even more dominant” as the currency in which most of that debt is denominated in.
The analysts said the current framework marks a “second phase” of global liquidity.
And it means markets are now “more sensitive to developments in the bond market, and even more tightly linked to US monetary policy”.
The chart below shows that after rising rapidly prior to 2008, growth in bank loans slumped in the GFC and has held flat since then.
“By contrast, outstanding international debt securities have risen from 48% in the first quarter of 2008 to around 57% of total international credit in the first quarter of 2018,” the analysts said.
The numbers reflect the “diminishing role of banks in driving international credit”.
What’s caused the shift?
The changes were driven to a large extent by European banks, which reduced their international loan exposures following the GFC and 2011’s Euro debt crisis.
Beneath the headline data, the fall in bank loans was driven four countries: France, Germany, the UK and the US.
Instead, more companies raised funding on debt markets, taking advantage of extra liquidity created by a low interest rate environment.
“At the same time, the US dollar has become even more dominant as the prime currency of denomination since the GFC,” the analysts said.
While the shift to towards bond markets has been more pronounced in developed economies, it’s the world’s emerging markets (EMs) which have been awash with USD funding.
The analysts said USD debt had been on the rise in Asian EM’s since 2010 along with Latin America, where USD credit has “historically dominated”.
And while Eastern European EM’s have historically tapped euro debt markets to raise capital, “yet the dollar dominates also in this region”, the analysts said.
That could spell bad news if the Fed takes a hawkish view of the US economy and the greenback strengthens
A stronger dollar increases tail risks for global investors holding a diversified portfolio of EM assets.
The analysts said the recent round of turbulence, when many EM currencies plummeted against the USD, could be attributed to that fact.
The research illustrates that as the world’s most liquid reserve currency, the USD has been the primary vehicle in the buildup of global debt since the GFC.
And is serves as a reminder of the risks facing peripheral economies if the Fed tightens monetary policy faster than markets are expecting.
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