Potential Bumps Ahead for U.S. Financial Markets RYAN SWEET, DIRECTOR OF REAL-TIME ECONOMICS SOHINI CHOWDHURY, DIRECTOR

Transcription

1 Potential Bumps Ahead for U.S. Financial Markets RYAN SWEET, DIRECTOR OF REAL-TIME ECONOMICS SOHINI CHOWDHURY, DIRECTOR May 2017

2 Financial Drag Can Be Significant Real GDP response to one std deviation in financial market stress Annualized % change, ppt -0.8 Confidence band -1.0 Magnitude of response -1.2 X-axis is quarters from shock Source: Moody s Analytics 2

3 1 Potential Bumps Ahead 3

4 Signs of Lofty Valuations Total market capitalization as a % of nominal GDP standard deviations Historical avg standard deviations Sources: Federal Reserve, BEA, Moody s Analytics 4

5 Still Room for Rates to Rise 10-yr Treasury yield decomposed, % Inflation expectations Term premium Expected path of real short-term rates Sources: Federal Reserve, Moody s Analytics 5

6 2 Here We Go Again, More Fiscal Brinkmanship 6

7 Brinkmanship Affects Interest Rates Yield on U.S. Treasury bills, % mo 3-mo Government shutdown /3/13 9/17/13 10/1/13 10/15/13 10/29/13 11/12/13 Sources: Treasury, Moody s Analytics 7

8 Perceived Credit Risk Jumped yr term premium, ppts (L) 1-yr CDS, bps (R) Sources: Bloomberg L.P., Moody s Analytics 8

9 3 Easing Off the Throttle or Applying the Brakes? 9

10 Fed Will Be Patient Then Aggressive Fed funds rate, % Eurodollar futures Moody's Analytics Fed-Mar SEP Jun-17 Dec-17 Jun-18 Dec-18 Jun-19 Dec-19 Sources: Federal Reserve, Bloomberg L.P., Moody s Analytics 10

11 Uncertainty Not Unusually High Rolling six-week standard deviation of 2-yr Treasury yield, bps Zero lower bound First rate hike this cycle Source: Moody s Analytics 11

12 A Misleading Relationship Source: Moody s Analytics Correlation between level of S&P 500 and Fed balance sheet 12

13 Initial Runoff Is Heavy on Treasuries Maturity distribution of Fed holdings of U.S. Treasuries, $ bil Sources: Federal Reserve, Moody s Analytics 13

14 4 What s the Deal With the Yield Curve and VIX? 14

15 Yield Curve Is Behaving as Expected Yield curve, bps Actual Fitted Source: Moody s Analytics 15

16 Watching for Warnings of a Recession 16

17 What s the Deal With the VIX? 17

18 5 What Does Uncertainty Mean for Risk Factors? 18

19 Swap Spreads Will Elevate U.S. interest rate swap spreads, bps, NSA Y 3Y 5Y 10Y Sources: Federal Reserve, Moody s Analytics 19

20 CDS Spreads Will Invert, Mimicking History North American investment grade CDS, par spread bid, bps, NSA 300 S4-scenario 250 1Y 3Y 5Y 10Y Sources: Intercontinental Exchange, Moody s Analytics 20

21 HY Corporates Will Be Deemed as Most Risky North American high yield CDS, par spread bid, bps, NSA 2,250 2,000 S4-scenario 1,750 1,500 1Y 3Y 5Y 10Y 1,250 1, Sources: Intercontinental Exchange, Moody s Analytics 21

22 Perceived Risk for Govt. Default Will Increase U.S. sovereign CDS, par spread bid, bps, NSA 80 S4-scenario Y 3Y 5Y Sources: Intercontinental Exchange, Moody s Analytics 22

23 6 Financial Market Risk Forecasts Modeling Methodology 23

24 Consistent With Macro Assumptions Two-stage process to generate forecasts ensures consistency between projections for macroeconomic and financial series.» Forecasts of the core macro drivers are produced in Moody s Analytics country models.» Forecasts are produced under standard baseline economic conditions as well alternative assumptions provided by regulators, clients, or Moody s Analytics scenarios.» Market risk forecasts are conditional on macroeconomic assumptions and their equations are subject to detailed validation and robustness routines. 24

25 Term-Structure Modeling Steps» Decompose the variation in the rates/spreads across all maturities into the level and slope components of the yield curve.» Forecast the level and slope components using the macro driver projections from the Moody s Analytics country models. Ensures consistent forecasts of the rates/spreads and the macroeconomic variables» Forecast each individual tenor point on the yield curve as a function of the level and slope components. Ensures consistent forecasts of the various tenor points on the yield curve 25

26 7 Financial Market Risk Forecasts Summary 26

27 Financial Market Risk Forecasts Coverage, Consistency, Documentation» We produce forecasts of a full range of market risk factors, including government bond yields, interest rate swaps, credit default swap spreads, swaption volatilities, ABS spreads, muni and corporate bond spreads, currency basis swaps.» The forecasts are Internally consistent (rank ordering among the curves follows historical relationships) Consistent with the macro assumptions under a given scenario» We can produce these forecasts for the Moody s Analytics baseline and alternative scenarios, for the Fed CCAR scenarios, and for any other client scenario.» We provide detailed, equation-level documentation, which includes results from various econometric tests. 27

28 Learn more about our Financial Market Risk Forecasts Service: Talk to an expert: ma.moodys.com/contact-expert-market-risk.html

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