LONDON, Sept 16 (Askume) – The Bank for International Settlements has urged central banks not to again exhaust interest rate buffers built up over the past few years and not to cut interest rates too quickly now.
The recommendation by the Bank for International Settlements (BIS) comes as markets await whether the Federal Reserve will begin its long-awaited interest rate cutting cycle this week by a quarter basis point or a half-basis point.
Claudio Borio, head of the bank’s monetary and economic department, stressed that its message to all central banks is that they need to maintain a certain “margin of safety” to be able to cope with expected economic downturns and unforeseen future crises.
“It would be a shame if this room for maneuver was wasted,” Borio told reporters on Monday as the Bank for International Settlements released its latest quarterly report.
“The expectation was that a recession would definitely come. The type of COVID-19 shock that we are seeing was unexpected. So that is another consideration to keep in mind when deciding the pace and how far to go.”
The Fed is widely expected to cut interest rates for the first time in four years this week, but other central banks, including the European Central Bank and the United Kingdom, Canada, Switzerland, New Zealand and many emerging markets, have already begun the process.
Given the current uncertainty in the global economy, markets are having difficulty understanding where interest rates are likely to settle in this cycle. Borio said the neutral interest rate, or r*, is a “rather vague concept” in economics textbooks.
“You won’t know where the star is unless you somehow get there,” he said.
Arbitrage trading
Reports from the Bank for International Settlements also point to sharp declines in US technology stocks and world stock markets in August, as well asWhen the Bank of Japan raised interest rates, the popular yen carry trade was abruptly discontinued.
The trade, which involves borrowing yen at a low cost to invest in other currencies and high-yielding assets, has supported the markets for decades.
In addition to the yen’s surge, August’s turmoil included the biggest one-day drop in Japan’s TOPIX bank index’s 40-year history and a sharp jump in the world’s leading market fear gauge, the Chicago Board Options Exchange Volatility Index (VIX)’ (.VIX) .
The estimated size of outstanding yen FX swaps and forwards has risen by about 27% since the end of 2021 to $14.2 trillion (1,989 trillion yen), said Hyun Song Shin, head of research and senior economic adviser at the Bank for International Settlements.
However, there isn’t enough information yet to tell how destabilizing opening carry trades could be.
“One of the things we need to do is get better data on the direction of the deal to understand what the actual economic objective of the deal is,” Shin said. “That’s something we’re working on right now.”
Disadvantages
The Switzerland-based Bank for International Settlements has also expressed financial stability concerns about the life insurance market’s use of offshore reinsurance (insurance by insurance companies) provided by private equity firms.
The report said this type of reinsurance is making the market “increasingly interconnected” and giving life insurers exposure to riskier assets, particularly in the United States.
Regulators around the world are also worried by the Bank of England’s threat to restrict the use of private equity-backed reinsurance by British life insurers .
The Bank for International Settlements warned that private equity firms “may be more vulnerable than their peers to difficult market conditions”.
(1 yen = 0.0071 USD)
