The global economic slowdown is becoming a key threat to financial markets. The measures taken by central banks may prove insufficient to prevent a negative outcome.
August 7, 2019   |   Dmitry Chernyadyev, Yulia Ushakova

In the first half of 2019, almost all assets in global markets showed positive trends: equity markets grew in both developed and emerging economies; in the majority of countries, bond yields decreased in both national and foreign currencies; the risk premium of emerging markets went down; and volatility returned to early/mid 2018 levels. This improvement in financial conditions on global markets was the result of a shift in leading central banks’ policies: they chose looser monetary policy over monetary policy normalization (i.e. raising interest rates that had remained extremely low for almost a decade). This shift was driven by increasingly obvious signs of a global economic slowdown and by the serious risks presented by the US – China trade dispute, which was not resolved at the G20 summit in Osaka. In developed economies, inflation is still below central banks’ targets, and slower growth leads to lower inflationary pressure, all other things being equal. This is one of the reasons central banks in developed countries are acting as they are.

The global economic slowdown is currently a key threat to global financial markets. There is a real risk that circumstances will change for the worse and emerging markets will face even larger capital outflow. Nevertheless, the events of 2018 – massive capital outflow from emerging markets and increased bond yields – are unlikely to repeat themselves, for several reasons:

  • Firstly, central banks in developed countries (the US Fed in particular) are pursuing a looser policy than they were a year ago. Last year, the Fed increased the interest rate four times and intended to continue policy normalization in 2019. This was one of the reasons capital fled emerging markets. Now, the Fed has announced possible interest rate decreases and is going to end its balance sheet reduction in September 2019, which in itself eases pressure on risky assets. Growth of both risky and defensive assets means that market participants consider measures taken by the central banks of developed countries sufficient to prevent further global economic slowdown;

  • Secondly, in response to the Fed’s interest rate increase last year, central banks in emerging countries increased their rates as well. Although this trend is now in reverse, current interest rates combined with looser monetary policy in developed economies are discouraging investors from leaving these markets.
  • Chart 1.
    Central banks’ interest rates

    The Fed

    Emerging markets (excluding Turkey and Argentina)

    6

    5

    4

    3

    2

    1

    0

    01.2017

    07.2017

    01.2018

    07.2018

    01.2019

    07.2019

    Source: central banks

    The Fed

    Emerging markets (excluding Turkey and Argentina)

    6

    5

    4

    3

    2

    1

    0

    01.2017

    07.2017

    01.2018

    07.2018

    01.2019

    07.2019

    Source: central banks

    Emerging markets

    (excluding Turkey and Argentina)

    The Fed

    6

    5

    4

    3

    2

    1

    0

    01.2017

    07.2017

    01.2018

    07.2018

    01.2019

    07.2019

    Source: central banks

    However, the steps central banks take could prove insufficient for preventing global economic slowdown. Factors that may compound the recession and make further recovery difficult persist:

    1. Substantial non-financial corporate debt

    Slower global trade growth and potential further global economic slowdown are undermining the prospects for corporate profit growth. This factor could play a crucial role in asset reevaluation and increased borrowing costs for business. The lenient financial conditions that supported the economy after the global crisis resulted in record-high corporate debt (see Chart 2). Moreover, recent equity offerings are characterized by lower ratings, while issuers have higher leverage; at the same time, the proportion of BBB bonds in investment-grade debt has risen (see Chart 3).

    Chart 2.
    Non-financial corporate debt (% of GDP)

    Total

    Developed economies

    Emerging economies

    300

    250

    200

    150

    100

    50

    0

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    2010

    2011

    2012

    2013

    2014

    2015

    2016

    2017

    2018

    Source: BIS

    Developed economies

    Total

    Emerging economies

    300

    250

    200

    150

    100

    50

    0

    2002

    2004

    2006

    2008

    2010

    2012

    2014

    2016

    2018

    Source: BIS

    Developed economies

    Emerging economies

    Total

    300

    250

    200

    150

    100

    50

    0

    2002

    2006

    2010

    2014

    2018

    Source: BIS

    In the event of another global recession, reevaluation of companies’ prospects – in the real and financial sectors as well as the private and public sectors – will lead to higher borrowing costs, refinancing problems, and massive downgrades. Lack of room for manoeuvre in certain leading countries’ fiscal policy (due to substantial public debt and/or weak political will) and monetary policy (due to low interest rates) could intensify the negative impact of poor credit quality on economic performance. As a result, economic recovery could take a relatively long time.

    Chart 3.
    Amount of BBB-rated bonds issued

    US (left scale)

    US (right scale)

    EU (left scale)

    EU (right scale)

    Debt share (%)

    Face value (trillion USD)

    50

    5

    40

    4

    30

    3

    20

    2

    10

    1

    0

    0

    2000

    2002

    2004

    2006

    2008

    2010

    2012

    2014

    2016

    2018

    Source: Global Financial Stability Report, April 2019

    US (left scale)

    US (right scale)

    EU (left scale)

    EU (right scale)

    Debt share (%)

    Face value (trillion USD)

    50

    5

    40

    4

    30

    3

    20

    2

    10

    1

    0

    0

    2000

    2002

    2004

    2006

    2008

    2010

    2012

    2014

    2016

    2018

    Source: Global Financial Stability Report, April 2019

    US (left scale)

    EU (left scale)

    US (right scale)

    EU (right scale)

    Face value

    (trillion USD)

    Debt share (%)

    50

    5

    40

    4

    30

    3

    20

    2

    10

    1

    0

    0

    2002

    2006

    2010

    2014

    2018

    Source: Global Financial

    Stability Report, April 2019

    2. High volatility of capital inflow in emerging economies

    According to the IMF, over the last decade, portfolio investment benchmarked against widely followed emerging market bond indices has grown by a factor of four, to 800 billion USD. The IMF estimates that about 70% of investment in emerging economies is volatile and responds swiftly to changes in market mood and global financial conditions. This investment can play a significant role in external shock transmission.

    If the global economy plunges into another recession, capital will leave emerging economies for defensive assets, i.e. developed economies. Emerging markets will face sudden capital stops that usually lead to exchange rate decreases, thereby increasing the debt burden of borrowers and cutting credit, internal demand, and output. This risk is particularly relevant for countries with substantial foreign currency debt. 

    3. Real estate boom

    Over the last five years, some countries have experienced growth in real estate prices (for example, housing prices in Hong Kong, Sweden, and Ireland gained on average 5% or more each year from 2013 until 2018), which requires regulators in these countries to take additional measures, primarily in macroprudential policy. Given the increased synchrony in housing price dynamics across countries (see Chart 5), there is a risk of a synchronous fall in real estate prices.

    Sharp price adjustments may hinder businesses’ access to funding (commercial property often serves as collateral for corporate loans; housing and commercial property prices correlate) as well as have a negative impact on consumption and generate problems in the banking sector. Housing prices are closely linked with macroeconomic and financial stability. Empirical studies show that recessions aggravated by falls in real estate prices are deeper and longer. As a result, in the event of global recession, countries experiencing a real estate boom are likely to suffer more than other countries.

    Chart 4.
    Average annual real estate price growth in economies and cities in 2013–2018:Q2 (%)

    City

    Economy

    Ireland/Dublin

    New Zealand/Auckland

    Australia/Sydney

    Canada/Toronto

    Norway/Oslo

    Denmark/Copenhagen

    Great Britain/London

    The Netherlands/Amsterdam

    Sweden/Stockholm

    German/Berlin

    Hong Kong/Urban areas

    Japan/Tokyo

    Switzerland/Zurich

    Austria/Vienna

    Belgium/Brussels

    USA/New York

    Spain/Madrid

    France/Paris

    South Korea/Seoul

    Singapore/Core central region

    Italy/Rome

    –4

    –3

    –2

    –1

    0

    1

    2

    3

    4

    5

    6

    7

    8

    9

    10

    11

    Source: Global Financial Stability Report, April 2019

    City

    Economy

    Ireland/Dublin

    New Zealand/Auckland

    Australia/Sydney

    Canada/Toronto

    Norway/Oslo

    Denmark/Copenhagen

    Great Britain/London

    The Netherlands/Amsterdam

    Sweden/Stockholm

    German/Berlin

    Hong Kong/Urban areas

    Japan/Tokyo

    Switzerland/Zurich

    Austria/Vienna

    Belgium/Brussels

    USA/New York

    Spain/Madrid

    France/Paris

    South Korea/Seoul

    Singapore/Core central region

    Italy/Rome

    –4

    –3

    –2

    –1

    0

    1

    2

    3

    4

    5

    6

    7

    8

    9

    10

    11

    Source: Global Financial Stability Report, April 2019

    City

    Economy

    Ireland/Dublin

    New Zealand/Auckland

    Australia/Sydney

    Canada/Toronto

    Norway/Oslo

    Denmark/Copenhagen

    Great Britain/London

    The Netherlands/Amsterdam

    Sweden/Stockholm

    German/Berlin

    Hong Kong/Urban areas

    Japan/Tokyo

    Switzerland/Zurich

    Austria/Vienna

    Belgium/Brussels

    USA/New York

    Spain/Madrid

    France/Paris

    South Korea/Seoul

    Singapore/Core central region

    Italy/Rome

    –4

    –2

    0

    2

    4

    6

    8

    10

    Source: Global Financial

    Stability Report, April 2019

    Chart 5.
    Annual growth (in real terms) of real estate prices in developed countries (%)

    10–90th percentile

    25–75th percentile

    Median

    40

    30

    20

    10

    0

    –10

    –20

    1971

    1974

    1977

    1980

    1983

    1986

    1989

    1992

    1995

    1998

    2001

    2004

    2007

    2010

    2013

    2016

    Source: Global Financial Stability Report, April 2019

    10–90th percentile

    25–75th percentile

    Median

    40

    30

    20

    10

    0

    –10

    –20

    1974

    1980

    1986

    1992

    1998

    2004

    2010

    2016

    Source: Global Financial Stability Report, April 2019

    10–90th percentile

    25–75th percentile

    Median

    40

    30

    20

    10

    0

    –10

    –20

    1971

    1980

    1989

    1998

    2007

    2016

    Source: Global Financial

    Stability Report, April 2019