Global Markets Are Stressed Out

Global Markets Are Stressed Out
Stéphane Renevier, CFA

over 1 year ago1 min

Cracks have started to show in the financial system: Credit Suisse just highlighted the runaway cost of insuring against a European bank default and the Bank of England was recently forced to intervene to support long-term bonds in the region.

That seems to be backed up by a rise in the office of financial research’s financial stress index (OFR FSI). The index estimates financial stress – that is, disruptions in the way markets normally function – in global financial markets using 33 financial variables. It’s normalized, so a value above zero means there’s more stress in the system than normal, while a value below zero shows there’s less.

The index’s rise shouldn’t be taken lightly: its current value is nowhere near the “extreme” levels we saw during the global financial crisis of 2008, true, but it is close to the levels that immediately preceded it. And in fact, volatility (orange area) is on the up while stock valuations (dark blue) are slipping, which is exactly what happened back then too. And sure, the stress from credit markets (light blue) isn’t quite as rampant today, but it’s certainly started to climb. The main differences this time around are that funding stress (yellow) – how easily institutions can finance their activities – is mostly contained, and safe assets (green) haven’t seen their prices rise due to stronger demand.

Now, this chart alone can’t tell us whether we’re headed toward better times or another 2008 crisis. It can, however, issue a clear warning that stress in the financial system has been piling up, which means the probability that something “breaks” is now higher. To limit your own personal stress, you might want to manage your portfolio conservatively, and make sure you’re not holding too much risk.

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