The chances of contagion between countries are high. In addition, after the crisis of 2007-2009, there has been no progress in the ability to control financial shocks. Speculation continues to run rampant and indebtedness continues to grow as a percentage of GDP.
Trade skirmishes, the deceleration of economies and the evolution of the interest rate curve are focusing our attention.
Financial stability conditions, however, have gone to the background, even though the links between the financial sector and the economy are important, as evidence reminds us.
Any episode that worsens the perception that is dominant today could lead to an increase in the price of risk, which, as we have seen repeatedly, could further contract the pace of economic growth.
The recent behavior of the interest rate curve has renewed the discussion about its anticipatory capacity for economic growth.
The historically low level of the curve, with more than $17 trillion of outstanding bonds with negative returns and the investment of its slope is a source of reasonable concern about the prospects for economic growth.
But they also give an idea of the risk assessment that financial markets are accumulating and, by itself, constitutes a vulnerability factor on financial stability.
The situation in recent weeks has not only not stabilized, but there are reasons to believe that the danger of “addiction”, of increased risk-taking in response to the relaxation of financial conditions, has increased indeed.
In addition, there are no signs in the near horizon, either in the direction of monetary policies or in the perception of the likelihood of economic slowdown, that the profiles of that temporary structure of rates will change significantly.
Some central banks, the ECB among them, given the expectations of containment of inflation, may try to take advantage of what is left in their toolboxes to avoid worse ills.
The behavior of the stock markets is also not very promising. Although the evolution of its prices has less predictive authority, we also have assumed that excessive volatility in its rates of return does not favor the establishment of expectations of economic growth.
The remarkable appreciation of gold, at a six-year high, as well as that of assets that use it as collateral is not a reassuring sign either.
It is justified, therefore, that the analysis of the evidence left by the summer be done with the background of some of the elements that defined the financial context long before.
There are at least four to be taken into account:
- The high degree of financial integration,
- The increase in private and public debt,
- The greater assumption of credit risks by financial companies other than banks,
- The dollarization of the debt of some emerging economies.
Despite the inflection following the emergence of the crisis, the interdependence of financial systems remains important, as indicated by the correlations between the financial variables of a growing number of countries.
As a result, the chances of contagion are high, due to the transmission capacity of international capital flows.
The evidence not only refers to the rapid spread of shocks but also to the possibility of amplifying them.
Recent history is full of those stampedes towards financial shelters caused by alterations in risk preferences, quite independently of the geographical location of the epicenter of disturbances.
In addition, it should be borne in mind that the ability to control the extent of these financial spasms has not improved as the complexity of the financial activity, insufficient information on the scope of certain risks and the consequent operational difficulty of many of the risk management models that financial operators handle continues to be unclear.
The financial supervision function itself does not have it much easier either.
The rise in indebtedness of non-financial companies is another feature offered by the international financial scene.
The growth experienced by the corporate bond market, in parallel to the decline in public returns, could be an exponent of that commented “addiction”, especially if the rate curve strengthens its current features and with them, public bonds continue at high prices.
In general, the average quality of these bonds has not increased in recent months.
The growth of leveraged loans deserves a separate mention, especially in the US financial system.
Their risk derives precisely from the fact that borrowers already maintain a high level of leverage and, perhaps for that reason, have to access the market in abnormal ways.
Public debt investors have also reduced their risk aversion. The prospects of anemic economic growth without inflation continue to rise before the increases in public debt, close to their historical highs in many advanced countries, both in absolute terms and in relation to the size of their economies.
Fortunately, the eurozone banks, with the exception of Italy, do not have as much public debt on their balance sheets as when the crisis accelerated that diabolical loop that formed the recession, the decline in bond prices and the deterioration in the quality of bank balances.
Not all the increase in credit risk driven by these monetary conditions complicit in the indebtedness is housed in the bank balance sheets.
Asset managers have increasingly entered the credit scene in recent years. Investment funds, for example, have increased their exposure to lower quality instruments by expanding the sources of possible spread in the event of solvency or liquidity problems.
This is the case of those funds specialized in direct financing to small and medium enterprises.
For somewhat different immediate reasons, risk outbreaks could be equally important in pension funds and life insurance companies.
In addition to the assumption of credit risks similar to the previous ones, these institutions are more concerned about the impact that the exceptionally low long-term interest rates of low-risk bonds could have on the long-term profitability requirements.
Experience also tells us that the sensitivity of emerging economies to financial contagion is high, regardless of their origin. Especially those indebted in currencies other than their own.
The denomination in dollars of part of the foreign indebtedness accentuates that exposure to the volatility of the US currency. Appreciative movements of the latter can significantly increase debt service. The case of Argentina, on the way to needing the greatest rescue in history, is difficult to ignore.
The inventoried elements are nothing but vulnerabilities over global financial stability. They are not new either.
All of them are part of the risk maps of which institutions such as the IMF or some central banks have been warning in their financial stability reports. As such risks, they may remain dormant for longer or complicate our lives a bit more if the slowdown is accentuated.