Systemic risks in global financial markets have remained relatively contained over the past six months, despite increases in some areas, says Moody’s Investors Service in a report.
It said more stable banking sector fundamentals have also been supportive of credit conditions over the past year.
Moody’s Managing Director, Credit Strategy and Standards and the report’s co-author Colin Ellis said financial conditions in global markets are more favourable than a year ago and are likely to remain so as global growth picks up and banking sector fundamentals remain stable.
“That said, there are potential downside risks from event related volatility in financial markets tied to elevated asset prices and banking sectors in Latin America and the Commonwealth of Independent States look relatively vulnerable,” said Ellis.
He said global economic activity has improved in 2017, with steady momentum reflected in a wide range of variables, including purchasing managers’ indices, industrial production, global trade and financial flows.
Ellis said Moody’s expect G20 economies to grow at an annual rate of slightly more than 3% in 2017 and 2018, higher than the 2.6% recorded in 2016.
Within financial markets, he said Moody’s assessment is that some systemic risks such as asset price and market risks, have increased in recent months.
“However, overall systemic risks look relatively contained with none of the six systemic risks we monitor being assessed higher than medium,” he said.
Ellis further elaborated that equity prices have picked up recently, moving above their 10-year average relative to nominal gross domestic product (GDP), while corporate bond spreads between investment grade and non-investment grade companies have settled at around 200-300 basis points in the US and the euro area.
Ellis said exchange rate risk has declined as political uncertainty has faded, notably in Europe following recent elections.
He said policy uncertainty has also declined but remain elevated while market liquidity has tightened in euro area’s government bond markets.
“While the banking sector’s fundamentals are improving and problem loans have bottomed out in most regions, the past improvement in capitalisation has lost some momentum. Banking systems with negative and stable outlooks have seen their profitability and efficiency positions improve over the past six months,” he said.
He said weak banking systems are currently not experiencing elevated asset prices, leaving them less exposed to risks of asset bubbles.
Ellis said countries in the south, which includes the euro area as well as Russia and Brazil, to be among the weakest systems in terms of high banking sector risk, yet score in the bottom range of asset price index.