D.he Bank for International Settlements (BIS) warns that the high valuations on the equity and bond markets will drift apart due to the uncertain economic outlook. In its quarterly report published on Monday, the “Bank of the Central Banks” mainly refers to the banks’ stricter lending standards, which are the result of the caution that has grown in the corona crisis. On the other hand, the purchases by the central banks would have caused the prices of corporate bonds to rise and depressed their risk premiums.
After the news about corona vaccines, the capital markets recovered significantly in November, writes the Basel-based BIS in its current quarterly report, which manages foreign exchange reserves for central banks and serves as an economic think tank. But now valuations are above or near pre-pandemic levels. At that time there were already questions about a possible overvaluation, said BIS chief economist Claudio Borio.
In addition to the central banks’ continued very expansive monetary policy, Borio cites the ongoing hunt for returns by investors, which leads to a higher risk appetite. But it is still unclear how the economy can cope with the repeated lockdowns in the second wave of the corona pandemic. Borio expects more corporate insolvencies, which is why the banks assessed their credit risks more cautiously.
Banking crisis still not ruled out
In his view, the banks entered the corona crisis with strong balance sheets, which was unusual. These now served as a buffer for the economy, which is why the banks would have to continue to have appropriate resources, i.e. capital and liquidity, at their disposal. To this end, the supervisory authorities have granted the banks capital relief so that they can continue to grant loans.
On the other hand, Borio can also understand the reluctance to pay dividends demanded by supervisors such as the European Central Bank. Investors may not be happy about this, but would also suffer if there were serious problems. Borio makes whether banks can get into a crisis in the face of bankruptcies and loan defaults on the further course of the pandemic.
The bond purchases by the central banks have pushed the volume of debt securities with negative interest rates back to the old record level of 17.5 trillion dollars. According to BIS economists Fernando Avalos and Dora Xia, the old relationship between US government bonds and stock markets has weakened significantly in recent years. If bonds had previously served as a safe haven for sell-offs on the stock market, prices in both markets have fallen simultaneously in the recent past.
Avalos and Xia justify this with the decreasing possibilities of the American central bank Federal Resverve for easing monetary policy after it, in contrast to the European Central Bank (ECB), ruled out the introduction of negative interest rates. In addition, there are signs that the banks are no longer providing the same amount of liquidity in the US government bond market as they used to be. Instead, new participants such as hedge funds or trading houses are increasingly active, which Avalos and Xia believe are more opportunistic. They are not ready to provide liquidity when it is needed most.
Scarce federal bonds
Avalos and Xia attribute the fact that the yields on ten-year bonds of the United States and Germany have developed differently since August to the different offer. While the yield on Bunds fell from minus 0.41 to minus 0.58 percent, the yield on ten-year Treasuries rose from less than 0.6 percent to more than 0.9 percent. In the United States, the expectation of a higher supply of government bonds depressed prices and caused yields to rise. In contrast, the Bunds available for private investors have decreased due to the high ECB purchases.