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Low global volatility is hiding credit risks

Monday, June 12, 2017

Subject

Downward pressure on bond yields.

Significance

Government bond yields rose in late 2016 as a result of higher inflation and expectations of US fiscal stimulus. However, although GDP growth is picking up in the euro-area, the United States and Japan, inflation pressures remain subdued and US fiscal plans have been delayed. Combined with falling political risk in the euro-area, this has pushed yields down and the global stock of negative-yielding sovereign debt is rising again. Moreover, ultra-accommodative monetary policies continue to supress yields, distorting asset prices and contributing to the mispricing of credit risk.

Impacts

  • China’s attempts to crack down on financial leverage is seen as a bigger risk by Bank of America Merrill Lynch than a euro-area break-up.
  • Despite the uncertainty of the UK election result, markets have been calm and the S&P 500 equity index hit a new intraday high on June 9.
  • The loss of momentum behind reflation trading has led the dollar index to fall by 5% this year and it will remain under pressure.
  • US technology shares fell sharply on June 9, raising concerns that their surge this year leaves them overvalued and at risk of a correction.
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