Markets Show They Aren't Prepared for the End of Stimulus - Bloomberg

Markets Show They Aren't Prepared for the End of Stimulus - Bloomberg



...As central bankers attempt to normalize policy, there is a risk that carry trades in financial markets will collapse, with a negative spillover to the real economy.

Central banks bought $21 trillion in government debt globally, pushing investors to search for yield in riskier markets. The result is a pyramid of trades dependent on stable interest rates: ...

...While carry trades flourished, the architecture of financial markets has become increasingly fragile. In 1976, Hyman Minsky wrote that a crisis can develop when financial structures amplify rather than dampen an initial shock. Today, there are a number of negative feedback loops across strategies that use leverage, buy illiquid assets or own a large percentage of their asset class. A bank-loan exchange-traded fund issues listed shares, but it takes between 30 and 60 days to settle a loan sale in the secondary market....



.... ETFs own 3.9 percent of U.S. high-yield bonds, more than the inventory of all broker-dealers put together. Together with quantitative funds, passive strategies represent 60 percent of traded volume in equities, according to JPMorgan research. 



...In the February sell-off, junk bond ETFs lost around 13 percent of their shares outstanding. Like instantaneous redemptions, these events force the ETFs to sell bonds in the secondary market to redeem shares, accelerating a sell-off. As the Bank for International Settlements warned in a report issued earlier this month, “The unique structures of ETFs might allow, or even encourage, less stable investment behavior by owners of these products.” Short volatility strategies act similarly. By selling volatility and put options in good times, they keep equities and credit spreads within a narrow range. Lower volatility, in turn, encourages more investors to pile into the same strategies. In a sell-off, however, the mechanism works the other way around.



...growth-linked debt for sovereigns, where coupons go down in a slowdown, reducing the need for austerity.



...explains the recent increased demand for haven assets including long-term U.S. Treasuries, German Bunds, Japanese government debt and emerging-market local currency debt. Investors are preparing for hurricanes while the sun is still out.