Echoes of ’07 as markets flirt with risk

Anthony Rowley
 6/2/2013 

THE Washington-based Institute of International Finance (IIF) yesterday issued an unusually blunt warning that global financial markets could again be in danger of "underpricing risk" in a manner reminiscent of the run-up to the global financial crisis that began in 2007.

The alert by the influential body, whose members include the world's leading banks and other financial institutions, comes at a time when stock and property markets are surging on the back of a sea of global liquidity, and could send a tremor through global markets.

It also comes as fresh concerns emerge in parts of the eurozone - Spain and Italy especially - over whether the financial crisis there has been laid to rest or may be ready to re-emerge.

Abundant liquidity created by central banks' monetary easing strategies - with Japan now joining the US and the eurozone in this regard - has "changed investor sentiment away from 'risk-off' to 'risk-on' mode", the IIF noted in its latest monthly Capital Markets Monitor.

January data reports "confirm the rebalancing of fund flows away from safe haven assets (US Treasuries, Bunds, UK Gilts etc) to riskier assets including equities and high-yield bonds", said the IIF.

"This has raised the question of whether credit risk is being underpriced again, as in the period prior to the 2007-2009 financial crisis," the institute said, using unusually pointed language.

Former undersecretary of the US Treasury for international affairs Tim Adams took over as managing director of the IIF at the beginning of this month and some are likely to see the warnings as reflecting official concern over the possible replay of a financial crisis.

Mr Adams, who was managing director of the Lindsey Group after leaving the government, succeeded Charles Dallara as IIF managing director.

Mr Adams noted at the time that he was appointed that the IIF "has developed a key role in many areas of global finance, and I am confident is poised to expand that role over the coming years as we face a period of unprecedented change".

The question of whether financial risk is again being underpriced "is particularly applicable in the case of the euro area where economic divergence between stronger core members and those on the periphery appears to be persisting, or widening in some instances", the IIF said.

The euro extended losses yesterday as political uncertainty in Italy and Spain prompted traders to take profit on the currency's strong gains so far this year, after it hit a 14-month high last week.

Italian and Spanish government bonds and stocks suffered a sell-off on Monday amid growing political uncertainty in the two countries that poured cold water on optimism that Europe is slowly healing from its debt crisis.

Spanish Prime Minister Mariano Rajoy faced calls to resign over a corruption scandal, while in Italy, the growing popularity of former premier Silvio Berlusconi was a worry for investors in the run-up to elections this month, Reuters reported.

"Perceived declines in tail risks and plentiful liquidity, with more resolute asset purchase programmes on the way from Japan, have noticeably changed investor sentiment and behaviour away from risk-off to risk-on mode," the IIF observed in its report.

"Since economic divergence has been among the root causes of tensions within the euro area, its persistence despite improvements in current account and unit labour costs raises the question as to when the euro area sovereign debt crisis can be regarded as over".

Global corporate bond issuance reached a record US$409.5 billion in January, after an unprecedented level of issuance of almost US$4 trillion in 2012, the IIF noted.

"Spread compression and near-zero policy rates in key countries mean that yields on many credit instruments have declined sharply. In particular, yields on USD and EUR corporate high-yield and sub-CCC bonds have fallen to multi-year lows recently."