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by sarosh
2023 days ago
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Probably the most interesting piece is "Box G: “Low-For-Long” Interest Rates and Implications for Financial Stability"
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" A longerterm risk is how the market participants’ exposures to greater levels of duration risk affect financial stability when rates eventually increase. The 2013 Taper Tantrum is an example of this potential dynamic, although the wider financial stability implications of that episode were limited. The potential risk here is that unexpected increases in rates negatively affect the balance sheets of financial institutions in such a way that leads to financial instability. Banks without adequate capital buffers could face solvency issues, while pension funds and insurance companies could
experience liquidity problems related to losses on
derivatives positions or increases in early liquidations.
Additionally, with valuations in both equity and credit
markets relatively high by historical standards and
likely to become further stretched in a low-for-long
environment, the risk of a sharp correction becomes
more likely, especially in conjunction with high levels of
leverage or excessive reliance on short-term wholesale
funding. Even small changes to expectations of far-in-the-future cash flow may have a disproportionate effect on current valuations when interest rates are low. As a result, such rate changes can lead to sharp adjustments in valuations. The potential negative effects that an unexpected increase in rates would have across
a variety of market participants make this longer-term
risk worth monitoring. Adequate guidance on the timing
and pace of any such policy-related increase will likely
reduce this risk." The 2013 Taper Tantrum refers to the 2013 collective reactionary panic that triggered a spike in U.S. Treasury yields, after investors learned that the Federal Reserve was slowly putting the breaks on its quantitative easing (QE) program. See https://www.reuters.com/article/us-usa-fed-2013-timeline/key... |
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