Downside Risks in Financial Markets have Increased
Bolstered by continued accommodative monetary policies in the advanced economies, financial market conditions have continued to improve. From March 2010 to March 2011, the S&P 500 rose by more than 13% while the MSCI Asia ex-Japan Index rose by almost 17%. Over the same period, advanced economy corporate spreads and high-yield credit spreads continued to narrow across different regions.
However, vulnerabilities persist, as highlighted by the bailouts for the peripheral Eurozone countries. In addition, geopolitical tensions in the MENA region and the disaster in Japan have heightened risk aversion and created spikes in market volatility. In Japan, equity markets fell by more than 17% in the first few days after the earthquake, but saw some recovery in the weeks after.
In the banking sector, concern about asset quality eased as the economic recovery progressed and banks raised capital ratios. However, this was overshadowed by refinancing concerns as large funding needs for banks coincided with those of national governments. Meanwhile, a renewed search for yield amongst investors appears to have begun. This has led to signs of a reduction in risk premiums in some segments of advanced countries' financial markets, as well as strong capital inflows to emerging market economies, increasing the risk of a possible build-up of asset bubbles and prompting many emerging market governments to tighten macroeconomic policies and introduce macro-prudential measures.
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