Heightened political uncertainties in Europe and the Middle East and global trade tensions have increased systemic risks in financial markets, according to a leading rating agency.
In a client report, Moody’s said bond markets are calmer than equity markets, but re-pricing remains a risk. Market liquidity has tightened alongside rising volatility in equity markets and capital inflows generally remain lacklustre across most emerging markets, the agency added.
Elevated private leverage will intensify any damage in the next credit downturn, said Colin Ellis, Moody's Managing Director for Credit Strategy and co-author of the report.
"We expect that ongoing trade tensions and political uncertainty will keep equity markets volatile. Equity prices still look elevated on some traditional metrics, but these may understate the impact of structurally lower real interest rates.
"Although bond markets have been calmer, the market is pricing in more cuts in the US policy rate by year end than indicated by the Federal Open Market Committee. As such, the resolution of this misalignment could generate bond market volatility."
Equity markets fell sharply in May on increased trade tension before rebounding in the following month on indications of further easing by leading central banks. According to Moody’s, equity prices still look elevated on some traditional metrics such as price-to-earning ratios, but these may understate the impact of structurally lower real interest rates.
In contrast, the bond market has been slightly calmer overall, despite some volatility in sovereign bond yields, where long-term government bond yields in higher-rated advanced economies declined further as investors reassessed the economic outlook.
Although the supply of safe assets remains steady, it is increasingly concentrated in US Treasury bonds, Moody’s added.
“The proportion of overall supply of Aaa-rated government bonds is on a par with 2008 levels, despite central bank purchases and a deterioration in sovereign credit quality. However, the lower number of Aaa-rated issuers and the increase in US Treasury bond issuance means that US Treasuries now account for around 75% of all Aaa-rated government bonds available, up from 50% in 2008. In addition, banks' low profitability constrains their ability to cope with the next downturn,” the agency concluded.
