This is not the first time that the Bank for International Settlements (BIS) has been concerned about the largely unregulated area of shadow banking, primarily hedge funds that rely on risky strategies. But the Basel-based Bank of Central Banks never tires of pointing out dangerous developments, including on Monday when it published its latest quarterly report.
600 billion dollars in the fire
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In it, the BIS economists warn of the high short positions taken by leveraged US investors in the futures market for US government bonds. In its quarterly report, the BIS put the volume of short positions at $600 billion.
This is comparable to the levels in September 2019 and March 2020, when turbulence in the US Treasury market forced the US Federal Reserve to intervene massively in the bond market to prevent worse. At the time, hedge funds had tried to exploit the price differences between the futures and spot markets.
Vulnerability in the financial system
Treasury futures tend to have premiums that are very low, which is why hedge funds seek to expand returns through high leverage. The BIS is therefore worried about "margin spirals". So-called margin calls are due if the prices do not develop in the direction of the respective sell or buy position. Then investors will have to inject cash, which had overwhelmed some in the run-up to the great financial crisis of 2008. The BIS views the recent build-up of these short positions as a vulnerability in the financial system that should be monitored.
According to a report by the Reuters news agency, BIS chief economist Claudio Borio sees the danger that inflation could be more persistent than previously assumed. Therefore, investment strategies that have relied on a rapid decline in interest rates are particularly vulnerable. The higher financing costs could also overwhelm corporate and mortgage debtors and cause loan defaults for banks.
The question arises as to how high the resilience of the entire financial system is to cope with these losses, Borio said. It is still unclear to him how high and persistent these losses will be.