Hopes that the worst of the financial crisis is over sparked a rally in the markets in the second quarter of this year, the world’s top central bank body Bank for International Settlements said Sunday.
However, the rebound failed to reach levels posted before the bankruptcy of US investment bank Lehman Brothers in September and concern is growing about governments’ abilities to pay back debt, BIS said in its quarterly review.
The dramatic collapse of Lehman Brothers led to a freezing up of bank lending as well as sharp falls in stock markets worldwide.
To unblock choked lending, central banks pumped liquidity into the markets. Meanwhile, governments also unveiled massive stimulus packages in a bid to lift the global economy out of a recession.
These moves “contributed importantly to the improvement in investor sentiment,” the BIS said.
“Glimmers of hope that the worst of the financial crisis and economic downturn had passed sparked a rebound in risk appetite among investors in the period between end-February and end-May,” it noted. Equity markets and credit markets all rallied.
However, they “remained some way off” pre-Lehman levels. In addition, investors are increasingly concerned about sovereign debt.
The BIS noted that sub-investment grade and sovereign credit-default swap (CDS) spreads were “still significantly high.”
CDS is a sort of insurance protection in case of defaults, and its spread is the premium paid by the insurance buyer to the seller.
High sovereign CDS spreads means that buyers of such insurance are made to pay more for the protection, suggesting that there is a higher chance that governments would default on their debt. Likewise, governments are now having to pay higher interests to attract investors to lend them money.
“Moreover, sharply rising deficits have led to concerns about the sustainability of public finances and the ability of some governments to fulfil their enlarged obligations,” said BIS.
“The resulting increases in real or perceived sovereign credit risk may in some cases have induced investors to require higher compensation to hold government debt, thereby pushing bond yields higher,” it added.
BIS cited Britain and the US as examples of countries whose sovereign bonds are fetching higher yields.
Emerging markets’ sovereign credit spreads appeared however to be going the other way. They are narrowing to levels just prior to the failure of Lehman Brothers.
“Investors .. regained their appetite for emerging market assets…Emerging market credit also tended to outperform mature markets,” noted the BIS.