The plumbing behind the world’s financial markets is creaking. Loud

LONDON (Reuters) – The coronavirus panic is shaking stock markets, and a sharp decline in key indices is catching the public’s attention. Behind the scenes, however, there is less understood and possibly more worrying evidence that stress in key arteries in the financial system increases to dangerous levels.

FILE PHOTO: Traders work on the floor of the New York Stock Exchange shortly after the closing bell in New York, USA, on March 13, 2020. REUTERS / Lucas Jackson

Bankers, corporations, and individual investors strive to provide cash and other assets that are considered safe in a downturn to overcome the chaos. This sudden escape to security is causing chaos in the bond, currency and credit markets to an extent that has not been seen since the financial crisis a dozen years ago.

The main concern now, like in 2008, is liquidity: the immediate availability of cash and other easily tradable financial instruments – and of buyers and sellers who feel safe enough to do business.

Investors struggle to buy and sell US government bonds, which are considered the safest of all assets. This is a very unusual event for one of the most easily tradable financial instruments in the world. Financing in US dollars, the world’s most traded currency, is becoming increasingly difficult outside the United States.

The cost of funding funds that companies use to prepare pay slips and other essential short-term needs is increasing for companies with lower ratings in the United States. The premiums that investors pay for taking out junk bond insurance are increasing. Banks charge each other more for overnight credit, and companies use their credit lines if they dry up later.

Taken together, warn some bankers, regulators, and investors, these red flags paint a troubling picture for markets and the global economy: if banks, businesses, and consumers panic, they can trigger a chain of cuts that will lead to greater funding for the crisis – and ultimately a deep recession.

Francesco Papadia, who oversaw the European Central Bank’s market operations during the region’s debt crisis a decade ago, said his greatest fear was that the “illiquidity of the markets caused by extreme uncertainty and panic reactions” would “freeze the markets.” could lead to “economic life-threatening event. ”

“It doesn’t seem to me that we’re already there, but we could get there quickly,” said Papadia.

A sign of the times is a hashtag that is now on Twitter: # GFC2 – an indication of the possibility of a second global financial crisis.

The warning signals to date are nowhere near as loud as in the financial crisis 2008-2009 or the debt crisis in the euro zone 2011-2012. And policymakers are very aware of the weaknesses in financial market installations. In the past few days they have intensified their reaction.

Central banks cut interest rates and pumped trillions of dollars of liquidity into the banking system. This week, the New York Federal Reserve, which spearheads the Federal Reserve’s market stabilization efforts, offered short-term loans of $ 1.5 trillion and announced it would buy a wider range of US Treasuries. It cited “highly unusual disturbances in the treasury bond market related to the coronavirus outbreak”.

“Based on the experience of 2008, central banks only know how to prevent a financial crisis from occurring,” said Ajay Rajadhyaksha, macro research director at Barclays Plc and a member of a committee that advises the US Treasury on debt management and US issues. Ministry of Finance advises the economy.


While the panicked markets are reminiscent of the 2008 financial crisis, comparisons only go so far. Central bankers have fresh memories of the shocks of the past decade. Another major difference: banks are in better shape today.

In 2008, banks had far less capital and liquidity than they do now, said Rodgin Cohen, chief executive of Wall Street law firm Sullivan & Cromwell LLP and top advisor to major US financial firms.

Instead, according to investors and analysts, the risk this time lies in the impact of the pandemic on the real economy: doing business with shutters, bans on travel and parts of the working population who are ill or quarantined. Freezing is a major blow to corporate earnings and profits and overall economic growth, and there is currently no end in sight.

Nationwide virus-blocking quarantines, such as in Italy, mean that “companies will be very badly hit in terms of revenue and earnings,” said Stuart Oakley, who oversees currency trading for clients at Nomura Holdings Inc., are still the same : If you own a restaurant and borrow money for the rent, you still have to make this monthly payment. ”

JPMorgan Chase & Co economists expect growth to decline worldwide in the first half of the year. And this is because the U.S. response to the coronavirus is just beginning.

(Graphic: Coronavirus meets link to financial markets:


Investors and regulators were particularly alerted to $ 17 trillion in liquidity problems in the US government bond market.

There are several signs that something is wrong. The interest rates or yields for government bonds and other bonds move in reverse to their prices: when prices fall, yields rise. Changes are measured in basis points or hundredths of a percent.

As a rule, yields move around a few basis points per day. Large and unusually rapid fluctuations in returns now make it difficult for investors to execute orders. Traders said traders on Wednesday and Thursday significantly increased the price differential at which they were willing to buy and sell government bonds – a sign of reduced liquidity.

“The tremor on the financial market is the most threatening sign,” said Papadia, the former ECB official.

Another alarming signal is that premium borrowers outside the US are willing to pay for access to dollars, a widely observed measure of a possible money crisis. The three-month euro-dollar swap spreads EURCBS3M = ICAP and dollar-yen JPYCBS3M = ICAP rose to their highest level since 2017 before falling on Friday after central banks pumped more cash.

A measure of the health of the banking system flashes yellow. The Libor-OIS spread USDL-O0X3 = R, which indicates that the risk banks are linked to mutual lending, has increased. The spread is now 76 basis points, down from 13 basis points on February 21 before the coronavirus crisis started in the west. In 2008, it peaked at around 365 basis points.

(Graphic: Link to dollar financing: here)

Weak corporate connection

While the financial markets are creaking, heavily indebted companies are feeling the heat.

Rating firm Moody’s warns that defaults on lower-rated corporate bonds could increase to 9.7% of outstanding debt in a “pessimistic scenario”, compared to a historical average of 4.1%. The default rate reached 13.4% during the financial crisis.

The cost of junk debt default insurance increased Thursday’s highest in the U.S. since 2011 and the highest in Europe since 2012.

Some companies are now paying more for short-term loans. The premium that investors are asking to hold riskier commercial paper compared to the safer equivalent rose to its highest level since March 2009.

Several companies draw on bank credit lines or expand their facilities to ensure that they have liquidity when needed. Bankers said companies fear that lenders will not be able to fund agreed credit lines if market turmoil worsens.

A major central bank official said the situation was “pretty bad because all the stars are negative”. “Cracks will appear soon,” said the official, “but it is still difficult to say whether they will develop into something systemic.”

Additional reporting by Sujata Rao and Yoruk Bahceli in London, Tom Westbrook in Singapore and Lawrence Delevingne and Matt Scuffham in New York; Edited by Paritosh Bansal, Mike Williams and Edward Tobin

Our standards:The Thomson Reuters Trust Principles.



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