Wednesday, July 25, 2012

Central banks supply safe havens in volatile times - BIS

    Central banks in emerging markets tend to push down global bond yields, including those of  U.S. treasuries, when financial markets are calm, but when market volatility spikes the process goes into reverse as banks sell their safe assets, providing liquidity to jittery investors, according to a working paper from the Bank for International Settlements (BIS).
    Global bond yields decline because central banks in emerging markets respond to capital inflows into their countries by buying dollars against their own currencies to resist the upward pressure on the exchange rates. Those dollars are then invested in bonds from major reserve currencies,  reinforcing the market's risk-on mode, wrote Robert McCauley, senior advisor at the Swiss-based BIS.
    "Thus, calm periods, marked by leveraged investing in emerging markets, lead to an asymmetric asset swap (risky emerging market assets against safe reserve currency assets) and leveraging up by emerging market central banks," McCauley wrote, adding:
    "In declining and volatile global equity markets, these flows reverse, and, contrary to some claims, emerging market central banks draw down reserves substantially. In effect emerging market central banks then release safe assets from their reserves, supplying safe havens to global investors."

    Click to read the BIS working paper: "Risk-on/risk-off, capital flows, leverage and safe assets"


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