Washington D.C., June 4, 2013 - Following their recent meeting in Rome, members of the IIF's Market Monitoring Group agreed today to release the following statement, noting:

1. A lack of fundamental support for financial market rallies:As Japan and Europe intensify efforts to use monetary policy to support growth, signs of potential underpricing of risk persist. With earnings growth and fundamentals still weak in many countries,the evident shift in portfolio allocations toward riskier assets, compression in credit spreads, and higher/more volatile equity prices is a source of concern.Signs of slower growth in key emerging economies also pose risk to export markets, especially for commodities. If a lack of growth and/or inflationary pressure were to prolong this period of exceptionally low rates in major mature economies, incidences of underpricing of risk-and the potential for disorderly reversals-would continue to accumulate.


2. Risks associated with exit strategies and a potential rise in U.S. bond yields:As U.S. policymakers debate a strategy of tapering off bond purchases (with little clarity as yet regarding timing and sequencing), U.S. long-term bond yields remain some 225-250 basis points below their average level in 2009-2010. A return towards these levels (particularly if abrupt) could have significant ripple effects, including:


1. Potential volatility in capital flowsto emerging market economies as "carry trades" become less appealing.


2. Raising the cost of servicing high budget deficits and public debtin mature market economies-given that in many cases debt-to-GDP ratios have risen in recent years despite efforts at fiscal consolidation.


3. Risks for recovery in Europe:If European bond yields-historically highly correlated with U.S. yields-were also to rise (and yield curves steepen), this could jeopardize a fragile economic recovery, particularly for Euro Area countries in the periphery;


4. Significant valuation losses for holders of bonds, including for central banks,which now have much higher exposure to government bonds and other fixed-income securities. The ECB could also be more exposed to credit risk given increased lending to banks against a widening range of collateral via its refinancing operations since 2010.


3. A need to reconsider zero risk-weighting of domestic government bonds for members of a currency union:private-sector bank holdings of domestic government bonds in some Euro Area member countries have increased - in some cases exceeding per-crisis levels. Such concentrations of credit risk-encouraged by the zero risk-weighting of domestic government bonds - could increase the negative feedback loop between sovereigns and their banks, if public debt sustainability in weaker member countries comes under question again.


4. Potential vulnerabilities exist in parts of the corporate sector,particularly in a number of Euro Area countries including Ireland, Portugal, Spain and Belgium, where corporate debt-to-GDP ratios are high. Recessionary conditions in many cases have hurt corporate profitability and investment spending, while increasing market fragmentation has meant that corporates in weaker countries often face higher funding costs as well. Moreover, corporate borrowers in some countries and sectors have increased leverage in the past few years, some to very high levels which may not be sustainable, particularly if interest rates were to rise. These same vulnerabilities can be seen in a number of Central and East European countries, along with currency appreciation- posing a risk to exports-in some cases.


5. Restrictions on trading "naked" sovereign CDS might impair market efficiency:In particular, these restrictions could impair market efficiency by increasing volatility and reducing liquidity in the sovereign CDS market, potentially constraining investors' ability to hedge sovereign risks by making hedging more expensive.




Note to editors:
The Institute of International Finance's Market Monitoring Group (MMG) is an independent forum of private-sector leaders in international finance and experienced market practitioners. The purpose of the MMG is to consider and identify potential systemic risks and alert market participants and policymakers to these risks. The MMG is co-chaired byJacques de Larosière, Chairman of Eurofi, former Managing Director of the International Monetary Fund and former Governor of the Banque de France, and byDavid A. Dodge, Senior Advisor of Bennett Jones, LLP and former Governor of the Bank of Canada.