Central banks should plan accordingly to toughen monetary policy and not let market volatility clout their judgment, the Bank for International Settlements has said ahead of the expected first rate rise by the US Federal Reserve in nine years.
The warning comes amid signs of growing investor alarm at the riskier end of the US corporate bond market, with borrowing costs for the lowest-rated companies climbing to their highest level since the financial crisis.
UBS estimated last week that up to $1tn of US corporate bonds and loans rated below investment grade could be in the danger zone.
The Fed resisted raising rates earlier this year in part because of market gyrations over the summer. Conditions have been milder ahead of this month’s meeting — although the BIS noted in its quarterly review that the “uneasy calm” in markets risked blowing up into bouts of financial turmoil.
Concerns over the possible impact of a US interest rate increase on more vulnerable borrowers have been exacerbated by rising indebtedness and shrinking revenues for many companies — especially in the stricken energy sector. This has fuelled fears that the profitable “credit cycle” that has reigned since the financial crisis receded is coming to an end.
Matthew Mish, a UBS strategist, said the Fed did not “fully understand the magnitude of the problems in corporate credit markets and the unintended consequences of their policy actions”.
Recent strong jobs figures have raised the likelihood of an increase in the federal funds rate when the Federal Open Market Committee, the Fed’s rate-setting board, votes on December 16. An earlier shift towards the exit by the US central bank sparked a “taper tantrum” in financial markets — a reference to the Fed’s decision to announce that it was tapering, or slowing, the pace of its asset purchases made under its quantitative easing package.
Despite the long-held belief by the BIS that “unthinkably” low interest rates were fuelling instability in global financial markets, the European Central Bank last week made the historic decision to cut a key interest rate even further, to minus 0.3 per cent.
The ECB’s announcement of more monetary easing this week showed “markets remain unusually sensitive to central banks’ every word and deed”.
The ECB also pledged last week to continue its QE plan to spend €60bn a month buying bonds until March 2017 — six months longer than originally planned.