According to the BIS’ latest Quarterly Review financial markets are starting to behave in some of the ways they behaved before the crash. In particular, investors seem to be chasing riskier and riskier assets, despite the fact that the economic prospects are hardly all that great.
Here is the key passage from the BIS report: “Some asset prices started to appear highly valued in historical terms relative to indicators of their riskiness. For example, global high-yield corporate bond spreads fell to levels comparable to those of late 2007, but with the default rate on these bonds running at around 3%, whereas it was closer to 1% in late 2007. (Sky News
“The same was true of investment grade corporate bond spreads, but with respective default rates of a little over 1% and around 0.5%. Indeed, numerous bond investors said that they felt less well compensated for risk than in the past, but that they had little alternative with rates on many bank deposits close to zero and the supply of other low-risk investments in decline.”
Bond yields usually move in line with the wider economy’s growth prospects, but clearly these two lines have started to diverge in recent months. There is something going on.
At least part of the likely explanation – and this is my interpretation rather than the BIS’ – is that the flood of money being set loose by central banks, including the Bank of England and the Federal Reserve, through quantitative easing is pumping asset prices higher.
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