Volatile Economies

[Benita Vandervoort]

Majorissues facing financial systems include inflation at multi-decadehighs, continuing deterioration of the economic outlooks in many regions,and persistent geopolitical risks, as we discuss in our latest GlobalFinancial Stability Report.

Financial vulnerabilities are elevated for governments, many with mountingdebt, as well as nonbank financial institutions such as insurers, pensionfunds, hedge funds and mutual funds. Rising rates have added to stressesfor entities with stretched balance sheets.

At the same time, the ease and speed with which assets can be traded at agiven price has deteriorated across some key asset classes due to volatileinterest rates and asset prices. This poor market liquidity, together withpre-existing vulnerabilities, could amplify any rapid, disorderly repricingof risk, were it to occur in the coming months.

Global markets are showing strains as investors have recently become morerisk-averse amid heightened economic and policy uncertainty. Financialasset prices have fallen as monetary policy has tightened, the economicoutlook has deteriorated, recession fears have grown, borrowing in hardcurrency has become more expensive, and stress in some nonbank financialinstitutions has accelerated. Bond yields are rising broadly across creditratings, with borrowing costs for many countries and companies alreadyrising to the highest levels in a decade or more.

The faltering property sector in many countries raises concerns about risksthat could broaden and spill over into banks and the macroeconomy. Risks tohousing markets are growing because of rising mortgage rates and tighteninglending standards, with many more potential borrowers now being squeezedout of markets. Stretched housing valuations could adjust sharply in somemarket segments.

Emerging markets are confronting a multitude of risks, including highexternal borrowing costs, stubbornly high inflation and volatile commoditymarkets. They also face heightened uncertainty about the global economy,and policy tightening in advanced economies.

Investors have so far continued to differentiate across emergingeconomies.While many frontier markets are at risk of sovereign default, many of thelargest emerging markets are more resilient to external vulnerabilities todate. Having said that,after the stabilization of outflows in the first half of the year,foreign investors are again pulling back.

Emerging and frontier market bond issuance in US dollars and other majorcurrencies has slowed to the weakest pace since 2015. Without improvedaccess to foreign funding, many frontier market issuers will have to seekalternative sources and/or debt reprofiling and restructurings.

The challenging macroeconomic environment is also putting pressure on theglobal corporate sector. Credit spreads have widened substantially, andhigh costs are eroding corporate profits. For small firms, bankruptcieshave already started to increase because of higher borrowing costs anddiminished fiscal support.

Central banks must act resolutely to bring inflation back to target andavoid a de-anchoring of inflation expectations, which would damage theircredibility. Clear communication about policy decisions, commitment toprice stability, and the need for further tightening will be crucial topreserve credibility and avoid market volatility.

Emerging and frontier markets should reduce debt risk through earlyengagement with creditors, multilateral cooperation, and internationalsupport. For those in distress, bilateral and private sector creditorsshould coordinate on preemptive restructuring to avoid costly defaults andprolonged loss of market access. Where applicable, theGroup of Twenty Common Frameworkshould be used.

Policymakers face an unusually challenging financial stability environment.Though no globally systemic event has materialized so far, they shouldcontain further buildup of vulnerabilities by adjusting selectedmacroprudential tools to tackle any pockets of risk. In this highlyuncertain environment, striking a balance between containing thesepotential threats and avoiding a disorderly tightening of financialconditions will be critical.

IMFBlog is a forum for the views of the International Monetary Fund (IMF) staff and officials on pressing economic and policy issues of the day.The IMF, based in Washington D.C., is an organization of 190 countries, working to foster global monetary cooperation and financial stability around the world.The views expressed are those of the author(s) and do not necessarily represent the views of the IMF and its Executive Board. Read More

The purpose of this paper is to scrutinize the interplay between resilience and agility in explicating the concept of resilient agility and discuss institutional and organizational antecedents of resilient agility in volatile economies.

The authors develop a conceptual framework that offers an original account of underlying means of ambidextrous capabilities for organizational change and behaviors in volatile economies and how firms stay both resilient and agile in such contexts.

The authors highlight that unfavorable conditions in volatile economies might have bright sides for firms that can leverage them as entrepreneurial opportunities and propose that firms can achieve increased resilient agility when high levels of institutional instability and estrangement are matched with high levels of EO and bricolage.

Turnover in global foreign exchange (FX) averaged more than $7.5 trillion per day in April 2022 amid a volatile market environment. Compared with the previous BIS Triennial survey in 2019, trading volumes were higher because of greater activity in short-maturity FX derivatives and more inter-dealer trading. By contrast, trading with customers stagnated, mirroring a slowdown in international investment in 2022. A greater share of trading was executed via various bilateral methods, rather than via multilateral platforms that make prices available to all participants, implying that the transparency of the FX market may have decreased further. 1

Turnover in global foreign exchange (FX) markets reached $7.5 trillion per day in April 2022 (Graph 1, panel A),2 a volume that is 30 times greater than daily global GDP.3 The Triennial Central Bank Survey of over-the-counter (OTC) foreign exchange turnover ("Triennial Survey") offers a glimpse into this vast FX market. This year in April, data collection coincided with heightened FX volatility due to a confluence of factors, such as changing expectations about the paths of future interest rates in major advanced economies, rising commodity prices and geopolitical tensions after Russia's invasion of Ukraine.

Global FX volumes were higher compared with the previous Triennial Survey in 2019, owing to two main drivers. First, more trading in short maturity FX derivatives, which mechanically increases turnover, under the assumption that many contracts are rolled over. And the greater use of short maturity derivatives may reflect market participants' aversion to taking on term risk in a more volatile environment. Second, more inter-dealer trading, which tends to rise with volatility. In fact, the rise in inter-dealer turnover was big enough to reverse the long-term trend of a declining inter-dealer share in global FX trading. By contrast, dealers' trading with financial customers stagnated, mirroring the slowdown in international financial investment activity.

Trading with hedge funds and principal trading firms (PTFs), and the associated prime-brokered turnover, also declined, suggesting some reduction in activity by non-bank financial intermediaries in the FX market.

The share of FX trading using various bilateral methods, where information about the trade remains private, has increased. This reflects both inter-dealer and dealer-customer trading shifting away from multilateral platforms. In the inter-dealer market, trading volumes executed via electronic brokers, where trade attributes such as prices can be seen by all participants, have thus continued to decline. The notable shift towards bilateral forms of trading in 2022 implies a continued reduction of "visible" trading and increased market fragmentation, suggesting that the transparency of the FX market may have decreased further.

The remainder of the feature starts with a bird's eye view of long-run trends. This forms the backdrop for discussing the Triennial results obtained this year amid more volatile markets than during previous surveys. The last two sections delve deeper into the dealer-customer and inter-dealer market segments.

While more than 50 currencies trade globally, FX trading activity is concentrated in a few trading hubs and major currencies. The Triennial captures sales desk activity in 52 jurisdictions for 56 currencies. Yet, close to 80% of all FX trading takes place in the five FX trading hubs that are major financial centres. Furthermore, as the pre-eminent vehicle currency, the US dollar was on one side of around 90% of all FX trades in April 2022 (see Box A), a share virtually unchanged for decades.

FX trading involves both spot and derivatives, with the share of spot having been on a gradual decline over the last 10 years (Graph 1, panel B). FX swaps are the most traded FX instrument and their share increased from around 40% in 2013 to more than 50% in 2022. They are typically used by market participants to take positions, manage funding liquidity in different currencies and hedge currency risk.4 Forwards are the third most traded instrument,5 used mainly to hedge currency risk or to bet on future currency movements. Their market share has edged up gradually over time.

The FX market can be broadly characterised as consisting of a dealer-customer and an inter-dealer segment. Such a two-tier structure is typical of OTC markets, where dealers warehouse risk and serve as counterparties, ie provide liquidity, to end users. Inter-dealer trading volumes used to exceed trading volumes with customers until about two decades ago due to inter-dealer trading of inventory imbalances.6 Thereafter, various structural changes resulted in relatively less inter-dealer trading (Graph 1, panel C). Examples include more efficient inventory risk management and "internalisation", whereby dealers match customer flows on their own books.

3a8082e126