Increased market volatility linked to rising trade tensions, elevated geopolitical risk and policy uncertainty and weaker corporate creditworthiness weighed on global financial conditions in the first half of 2018, according to Moody's Investors Service.
In its latest Financial Monitor, a quarterly research report that provides the rating agency’s views on developments in financial markets and global banking systems, the following key points were highlighted:
- Economic policy uncertainty remains and geopolitical risk is elevated, but global financial risks are still moderate
- Weak creditworthiness indicates higher defaults for non-financial corporates in the next downturn
- Tightened financial conditions could further strain vulnerable emerging-market currencies and bonds
Colin Ellis, Moody's Managing Director – Credit Strategy and the report's co-author, said: "While systemic financial risks have increased somewhat in the first half of 2018, the continued easing in credit standards suggests investor risk appetite remains strong. However, credit spreads are likely to widen significantly if risks crystallize."
Moody's measures of asset prices declined moderately in the first half of 2018, with government bond prices falling from high levels amid market expectations of higher interest rates.
The recent rally in US government bond yields reflects the solid economic recovery and rising US inflation expectations, which for now look consistent with the Federal Reserve's target. In contrast, government yields in the euro area core countries remain compressed as the economic cycle and monetary policy lags that in the US.
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Declines in US and other equity indices have accompanied the threat and subsequent imposition of US tariffs on a range of countries and exports -- and the proportionate and reactive tariffs on US goods from China, the European Union and others.
Property prices dipped in most countries during the first half of this year, with price levels generally below 10-year averages relative to nominal GDP. However, house prices remain elevated in a few markets, including Norway, Sweden, New Zealand and Australia.
On the banking side, funding could be a key risk in some markets if investor confidence erodes and funding dries up. The Turkish banking system is the most exposed to funding shocks.
Any tightening in financial conditions could strain vulnerable emerging market currencies and bonds.
The most vulnerable sovereigns are generally those with low debt affordability, shorter maturities and high debt levels. While some frontier market sovereigns are among the most vulnerable countries, Argentina and Turkey show the highest risk among emerging markets.
The report, "Moody's Financial Monitor, Current conditions mask risks that will crystallize when the cycle turns", is available on www.moodys.com for Moody’s subscribers. The research is an update to the markets and does not constitute a rating action.
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