The financial markets are showing signs of normalizing, with interbank money markets recovering to levels not seen since early last year, the world’s biggest central bank body said on Sunday.
“Despite uncertainty about the pace of economic recovery, investors remained cautiously optimistic in the period between end-May and early September 2009,” the Bank for International Settlements (BIS) said.
NARROWER SPREADS
In particular, “in interbank money markets, key spreads narrowed to levels not seen since the beginning of 2008,” the BIS said.
The spread of US rates even fell to the lowest level since the outbreak of the financial crisis in mid-2007, it said.
The LIBOR/OIS spread — or the premium that the London interbank offered rate (LIBOR) trades over the overnight swap rate (OIS) — is often taken as an indicator of the level of stress in the money market.
In the aftermath of the collapse of venerable US bank Lehman Brothers, the spread widened sharply as lending froze up. Central banks had to take the extraordinary action of pumping in tonnes of liquidity to get lending flowing again.
In its latest quarterly statistical review, the BIS said that “signs of receding liquidity premia and rebounding risk tolerance were also evident in bond markets.”
However, there was great volatility in the bond markets as investors appeared to be unsure about the pace of recovery.
“Over time, bond investors seemed to increasingly take the view that the worst of the economic downturn was over, but that recovery was likely to be gradual and vulnerable to setbacks,” it said.
“This, in combination with low expected inflation, led them to scale back expectations that monetary policies would begin to normalize anytime soon,” it said.
CLEARINGHOUSES
Meanwhile, central banks must coordinate global supervision of derivatives clearinghouses and consider offering them access to emergency funds to limit systemic risk, the BIS said.
Regulators are pushing for much of the US$592 trillion market in over-the-counter derivatives trades to be moved to clearinghouses which act as the buyer to every seller and seller to every buyer, reducing the risk to the financial system from defaults. The drive was spurred by the collapse of Lehman Brothers and the rescue of American International Group Inc, two of the biggest credit-default swaps traders.
“The crisis has exposed the need for international coordination of the oversight of systemically important” clearinghouses, BIS analysts Stephen Cecchetti, Jacob Gyntelberg and Marc Hollanders wrote in a report published on Sunday.
An important and unresolved question is whether clearinghouses “should have access to central bank credit facilities and, if so, when,” they wrote.
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