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-- Continuing Recovery in the International Financial Markets and Policy Responses
-- Developments in Domestic Financial Markets in the Second Half of 2009
-- Points to Be Noted in the Financial Markets for the Foreseeable Future
-- Issues Regarding the Functioning of Financial Markets and the Bank of Japan's Actions in 2009
February 26, 2010
Bank of Japan
Around spring 2009, market participants' risk appetite (investors' willingness to take risks) recovered quickly as excessively heightened concerns about financial system stability eased and an increasing number of market participants started to expect economic activity to bottom out against the background of the progress in inventory adjustments. Nonetheless, a wide range of economic agents were suffering from excess debt in the United States and Europe, and investors were sensitive to developments in international financial markets. Thus, it was uncertain whether the recovery in risk appetite would be sustainable. In fact, following the turmoil in global financial markets triggered by the Dubai shock, investors' attitude toward investment became somewhat cautious. However, since the major central banks clarified their stance of continuing the low interest rate policy, investment in risky assets continued, albeit at a slower pace. Such financial flows were seen in not only developed economies but also emerging economies with relatively high expected growth, and stock prices and currencies of these emerging economies continued to be on an upward trend. Real estate prices in some economies and commodity prices also rose. These recovery and rise in a wide range of asset prices seemed to be attributable to the accommodative financial environment maintained by major countries. On the other hand, market participants became concerned with the possibility that the expectation of a continuation of the low interest rate policy in the developed economies might accelerate financial flows to the emerging economies, and that changes in expectations might trigger an abrupt reversal of such financial flows.
In the second half of 2009, interest rates remained stable in money markets, as seen in the moderate decline in interest rates on term instruments reflecting the continued provision of substantial liquidity by the Bank of Japan. There seemed to be no adverse effects from the decision to terminate various temporary measures such as outright purchases of CP. Conditions in credit markets generally continued to improve, as credit spreads on corporate bonds -- not only those with high ratings but also those with medium and low ratings -- narrowed moderately. Although there was a concern about a deterioration in the supply and demand conditions in government bond markets, Japanese government bond (JGB) yields generally stayed within a certain range. While U.S. and European stock prices rose steadily, Japanese stock prices were relatively weak. Particularly in late November 2009, due to the further appreciation of the yen against the background of the depreciating trend of the U.S. dollar against major currencies, stock prices fell further. After December 2009, when the Bank held an unscheduled Monetary Policy Meeting and decided to further enhance easy monetary conditions, however, the yen depreciated somewhat, and stock prices started to rise.
Looking toward the developments in the financial markets for the foreseeable future, it remains important to focus on the factors that affect the interaction between the real economy and the international financial markets. On the real economy side, we need to carefully monitor how deleveraging (process of debt reduction) in the household as well as banking sectors -- for example, in the United States -- proceed and how they affect the financial sector in their rewinding process. Concerning the international financial markets, the issue of how investors' attitude to risk may change is attracting attention. At the moment, the investment attitude by global investors has been recovering but still remains sensitive to such risks including event risks like the Dubai shock. In this regard, global investors pay attention to the continuity of the low interest rate policy. So far, the low interest rate policy implemented by major countries has contributed to activating the real economy via asset price appreciation. On the other hand, global investors actively invest in emerging economies. There could be a large impact on the global economy depending on how the international financial markets respond to a situation in which financial flows into the emerging economies accelerate or when a sudden reversal occurs due to the changes in expectations. Another point noted by global investors is the deteriorating fiscal balances of major countries. Depending on the perspectives on the fiscal balances, investors could further increase their investment position to steepen the yield curve. It is thought that Japanese financial markets are becoming increasingly related to the international financial markets. Thus, it is important to consider the above points when projecting future developments in domestic as well as international financial markets.
After the failure of Lehman Brothers Japan Inc. in September 2008, in the JGB repo market, where the significant effects such as a decrease in liquidity were seen, the following were recognized as priority issues to be examined by all relevant parties in the markets: (1) improving market practices, mainly establishing and reviewing the fails practice; (2) enhancing the functions of and promoting the utilization of the Japan Government Bond Clearing Corporation (JGBCC); and (3) improving risk management by shortening the JGB settlement cycle. These issues have been discussed among market participants. Additionally, measures to enhance financial market activities have been examined in corporate bond markets, securitization markets, over-the-counter (OTC) derivatives markets, and CP markets. Furthermore, the business continuity plan (BCP) in financial markets has been enhanced in order to strengthen the resilience of the financial markets in the event of a disaster. The Bank hopes that market participants will continue to take initiatives related to improving market practices and infrastructure in financial markets, and the Bank will continue to support such private-sector initiatives.
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Financial Markets Department, Bank of Japan
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