LONDON, March 6 (IFR) - High levels of correlation that have
characterised financial markets since the global financial
crisis have broken down in recent months, according to the Bank
for International Settlements.
Returns between asset classes, regions and sectors have
diverged, the BIS notes in its latest report released today on
the three months to end-December. Political uncertainty and
divergent monetary policy have replaced the large swings in
investor risk appetite that acted as a driver of overall
valuations in recent years.
“Politics tightened its grip over financial markets in the
past quarter, reasserting its supremacy over economics,” said
Claudio Borio, head of the monetary and economic department at
Cross-asset correlations have been on the decline since late
2015, according to the BIS, but plummeted following November's
US presidential election.
"The breakdown in correlations stands in stark contrast to
most of the post-crisis experience, when successive waves of
risk-on/risk-off behaviour tended to raise and lower all boats,"
"This break with the past is yet another sign that the
markets’ close dependence – dare I say overdependence – on
central banks’ utterances and actions was at least temporarily
weakened during the quarter."
In response to the deregulation and fiscal expansion
promised by the new US administration under President Donald
Trump, US stock markets have soared to new highs while 10-year
Treasury yields hit a two-and-a-half year high of 2.6%
immediately following the election.
Within stock markets, investors displayed greater
discrimination, piling into reflationary sectors such as
defence, construction and manufacturing, while import-intensive
sectors lost ground over the quarter.
In the euro area, elections and expectations of QE tapering
by the ECB also drove asset price divergence. Sovereign spreads
in France widened in response to forthcoming elections. Ten-year
OATs traded as much as 80bp wide of German Bunds, settling back
to around 60bp wide at current levels.
TARGET2 imbalances increased during the quarter, in some
cases exceeding levels seen during the 2012 sovereign debt
crisis. Those imbalances were driven by a capital flight from
ailing peripheral economies to markets perceived to be safer,
such as Germany, Luxembourg and the Netherlands. This time,
imbalances appear to have emerged as a by-product of the ECB's
asset purchase programme.
BIS analysts Raphael Auer and Bilyana Bogdanova note that
many ECB purchases are conducted by national central banks
located in other countries. For example, the Bank of Italy buys
securities from a London-based bank that connects to the T2
system via a correspondent bank in Germany.
"The purchase amount is credited to the account of the
German correspondent bank at the Deutsche Bundesbank, thus
increasing the T2 surplus of the Bundesbank. Similarly the Bank
of Italy's T2 deficit widens."
In December, the European Central Bank confirmed that it
would slow the pace of monthly asset purchases to €60bn from
€80bn starting in April. At the same time, it extended the
duration of the purchase programme to December 2017, or beyond
The BIS also notes ongoing tensions in China's financial
markets, where a liquidity squeeze contributed to a sharp
increase in domestic bond yields. Pressure from capital flows
has driven wild swings between onshore and offshore renminbi,
creating a daunting task for policymakers as they grapple with
the triple challenge of historically high indebtedness, large
portions of the corporate sector indebted in foreign currency
and growing internationalisation of the currency.
"Such tensions were just the latest reminder of a global
economy that is struggling to find a safe passage towards a
sustainable financial stress-free expansion," said Borio. "In
more ways than one, the long shadow of the great financial
crisis is still hanging over us."
(Reporting by Helen Bartholomew)