The disconnection between (stock and bond) markets and fundamentals is due to abundant macro-liquidity and repeated central bank (CB) intervention. After years of complacency, data signal risks ahead: across the world, growth is slowing; leading indicators point to a mild global recession, driven by an EM slowdown; volatility and financial stress are rising and macro-liquidity is not translating into consistent market-liquidity. Policy interventions are unlikely to be effective. In this context, CBs risk making policy mistakes and, eventually, losing credibility. The recent episode of market volatility was an early-warning: when CBs start tightening, a bear-market correction will ensue and asset prices will decline to match fundamentals. Capital preservation via a defensive asset allocation is priority. Yet, unusual portfolios – less liquid and more volatile – are likely to perform better than conventional ones.
A.The world’s economy and stock markets are reaching an unstable equilibrium. In nominal terms, since the 2008 crisis the global economy grew by 22.7 percent and the global equity markets by 118.9 percent (Endnote 2, Table 3). Over the years, the disconnect between economic fundamentals and financial asset prices has widened. The result is an unstable equilibrium (imagine a large sphere on top of a hill), where a small disturbance can produce momentous changes. Over the same period, bonds rose by 26.3 percent, slightly above fundamentals, while commodities rose by only 2.1 percent, signaling lower growth ahead.
- The paradox: most economies are weak … Since the crisis, the recovery has been weaker than expected. In real terms, the world economy has grown at a compound annual growth rate (CAGR) of 3.3 percent; developed markets (DMs) at 0.9 percent and emerging markets (EMs) at 5.2 percent (Endnote 3, Table 4). Year after year, growth fell short of expectations. Despite improvements in the labor markets, inflation is still below CBs targets
- … but stock markets are strong. Between March 1, 2009 and September 30, 2015, despite the ongoing market turmoil, the equity markets rose at a significantly higher rate than the real economy: the Dow Jones Global Index grew – without a correction for about 128 weeks (2.5 years) – at a CAGR of 12.6 percent. In the bond markets, the JPM Global Aggregate Bond Index grew at a CAGR of 3.6 percent, with no significant correction. Commodities were stagnant: the Rogers International Commodity Index (RICI) benchmark registered a CAGR of 0.3 percent, without significant correction (Endnote 3, Table 4)³.
- Financial asset prices are well above fundamentals. As a result, current valuations are significantly above historical levels. According to Deutsche Bank, global markets (stocks, bonds, and residential housing) are above their pre-crisis (2007) price levels and close to an all-time peak. At end-September 2015, the price-to-earnings ratio (PE) on the S&P Global 1200 index was 16.4, 82.2 percent above the pre-crisis average of 9.0 (1997-2007 period). Due to large CBs purchases of government bonds and low inflation, bonds’ yields are at multi-century lows.
B. Financial markets and fundamentals got disconnected, complacency is hindering growth. Across the world, CB-liquidity injections upheld economic performance by creating a “low-growth equilibrium”, but boosted financial markets. Yet, in the real economy, liquidity-induced complacency hampered reform-efforts and delayed investments.
- In a context of abundant macro-liquidity … To counter the 2008 crisis, an unprecedented amount of money – about 25.6 trillion (tn) of US Dollar (USD), or 33.2 percent of the world’s Gross Domestic Product (GDP) – was thrown at the global economy. At once, DM and EM governments provided fiscal stimuli by increasing spending. Since 2007, DMs’ average debt-to-GDP ratio has risen by about 50 percent; in Britain and Spain it has nearly doubled. To date, total fiscal stimuli amount to at least USD 17.7tn, or 23.0 percent of world GDP. Over the same period, the world’s main CBs slashed interest rates and supported the financial system by almost doubling – from USD 10.1 to USD 17.9tn – their combined balance sheets. To date, the total amount of monetary stimuli is about USD 7.8tn, or 10.2 percent of world GDP. As the economic recovery consistently proved weaker than expected, governments shelved fiscal consolidation and CBs repeatedly postponed tightening.
- … when there is trouble, CBs to the rescue! Between March 2009 and September 2015, market capitalization (a proxy of financial markets’ liquidity) more-than-doubled: from USD 11.3tn to USD 23.3tn. The financial markets got used to prompt CBs intervention, aimed at encouraging risk-taking whenever the macroeconomic outlook deteriorated and after each shock – be it an ‘earlier-than-expected’ US Federal Reserve (Fed) exit, the sharp drop in oil prices, the Greek crisis or China’s devaluation. Short- and long-term interest rates were kept low (and even negative in some cases, such as in Europe and Japan) and quantitative easing (QE) widely practiced.
- The status quo is convenient … Over and over, the arrangement worked – and it still works. CBs create short-term macro liquidity to contain volatility and avert further price deterioration; immediately, equity markets rise and bond yields decline. Since 2009, the prices of all asset classes rose, almost in sync: equities, fixed-income private-and-public-sector bonds and commodities (Endnote 1, Table 3) – but also real estate. Over time, CBs liquidity fed price bubbles and market prices decoupled from economic fundamentals. Only recently commodity prices dropped, in line with fundamentals[i].
- 4.… but liquidity has created complacency, which hampers long-term growth prospects. In both DMs and EMs, cheap money created a culture of complacency. Abundant liquidly – putting creative destruction on hold – kept governments, banks and companies afloat but brought about zombie-entities, which deliver low growth[ii]. Today, policy makers can afford delaying structural reforms, entrepreneurs borrow to re-finance their debts and back their own shares, not to invest in the real economy. Markets suffer from risk-myopia, i.e. financial agents ride “beta” with full leverage and without significant hedges, taking excessive risks for relatively low returns.
C. Across the world, growth is slowing. The global economy is fragile, still recovering from the 2008 financial crisis. In 2014, world retail sales increased by a meager 2.3 percent yoy. In 1H-2015, global economic output expanded by barely 2 percent (the weakest two-quarter period since mid-2009); lower demand for commodities depressed (real) prices and contributed to reducing global inflation; world trade growth turned negative (‑0.7 percent). In 2016, the globe will enter a mild recession35, mostly driven by EM weakness, led in turn by China’s slowdown. Real GDP growth will dip to 2.6 percent. DMs – hampered by aging populations, slow structural reforms, low productivity growth, high public and private debt and reduced policy options – will stagnate at 1.0 percent. EMs will grow below potential, at 3.6 percent (Table 1).
- Leading indicators suggest EM weakness … OECD’s Composite Leading Indicator (CLI) points to a relatively stable growth momentum in DMs, but to a deteriorating outlook in EMs. The Conference Board Leading Economic Indices (CB LEI) hint at declines in future economic activity in Brazil, Russia and India. The JP Morgan Global Manufacturing Index indicates a slim expansion of global manufacturing, but recent readings of the relevant Purchasing Managers’ Indexes (PMI) show an ongoing contraction in major EMs, such as Brazil, Russia and China. In 1H-2015, global merchandise exports declined by 10.7 percent year-on-year (yoy), due to slowing growth in EMs and a sluggish recovery in DMs. The Baltic Dry Index, an indicator of global trade, declined by 14.7 percent yoy as of September 30, 2015, highlighting a deterioration in demand for sea-shipping. Home sales across the major economies have shown signs of recovery but the Global Consumer Confidence Index (CCI) shows moderate, widespread pessimism. The recent decline in global stock prices5 and, in most countries, in corporate earnings growth also suggests declining growth ahead.
- … rising the odds of a global recession. Across the world, economic growth is stifled by necessary balance sheet adjustments and an “at-best-sluggish” pace of implementation of structural reforms. Most countries – especially systemically important EMs (Brazil, Russia and China) – are decelerating. The EU and Japan are stagnating and will not uphold global growth. China’s slowdown is likely to be a bigger-than-expected drag on the world’s economic output. In this context, the US will find it difficult to continue growing and lift the rest. If the US were to decelerate while DMs are weak and most EMs are in a slowdown, the first ‘post-2008 global recession’ would ensue.
- Bull case: 10 percent. Global economic activity will accelerate to 3.5 percent, supported by DMs (2.1) and helped by a soft-landing of EMs (4.4). Improved economic and corporate performance will allow a gradual interest rates normalization. The tightening cycle will start in the US and UK, EMs will follow. Higher interest rates will restore the savings function in DMs, leading to increases in private investment. DM equities will rally and DM bonds will sell off.
- Base case: 70 percent. The globe will enter a mild recession, with growth declining to 2.6 percent, dragged down by a cyclical deceleration in EMs (3.6), led by China’s downturn – which will further hamper EM exports and commodity prices – and the ongoing recession in Russia and Brazil. Should most EMs enter in recession, DMs will decelerate (1.0), unable to prevent a global slowdown. Policy normalization would start in 2H-2016, with the US taking the lead, followed by the UK and key EMs. In this scenario a financial crisis is unlikely. Yet, EM stocks will suffer a cyclical bear-market (-20 percent, at least) and DM bonds will be sought after.
- Bear case: 20 percent. Global real GDP growth will fall to 1.9 percent, driven by financial distress and a significant deceleration in EMs (2.9). DMs will stagnate (0.3). An EM financial crisis is likely, spurred by low commodity prices, increased debt levels, and political instability – especially if the Fed were to initially hike interest rates. As a result, stocks would initially suffer a deep bear-market (-40 percent). In DMs, interest rates will remain close to zero and the US will eventually launch QE4, possibly extended to purchases of private sector assets. Eventually, DM stocks will rally, and carry trade will support EM stocks. Bonds will benefit across the board.
Table 1. – 2016: how economic fundamentals will impact monetary policy and financial markets
Source: Author’s elaboration, 2015.
Note: global recession35 = global growth < 3 percent. Numbers are rounded for explanatory purposes. Economic fundamentals: global growth’s 2016 weights = DMs 0.39 (US: 0.17; EZ: 0.14; Japan: 0.05; UK: 0.03) – EMs 0.61 (China: 0.34; Brazil: 0.09; Russia: 0.08; India: 0.07; Saudi Arabia: 0.03). Markets: In each scenario, “+” and “–” indicate the 2016 performance of a given asset class, relative to other asset classes. *=ECB and BoJ to ease further in 2016. **BCB, CBR, PBoC, and possibly RBI to ease further in 2016.
D. Economic risks: policy out of ammunitions, recession in EMs. The current equilibrium, if disrupted, will not be restored through the fundamental workings of the market. Yet, policy makers around the world lack the tools to address another crisis. Unlike during the 2008-09 recession, governments and CBs have almost no room to stimulate the economy by getting further in debt or cutting interest rates. A strong fiscal response is unlikely due to severely constrained fiscal spaces, high debt levels and a lack of political will. On the monetary side, interest rates are near zero, CBs’ balance sheets are larger-than-ever14, and the effectiveness of unconventional policies is widely questioned. Policy mistakes, due to wait-and-see attitude or political deadlock, could induce a hard-to-escape recession.
- CBs tightening will be further postponed … The Fed is likely to postpone hiking rates until 2H-2016 (Table 1). A tightening cycle will be seen as hampering: a) structurally fragile EMs via financial outflows; b) US competitiveness via a stronger USD and; and c)market risk-appetite, by pushing leveraged investors to scale back their positions. Both the European Central Bank (ECB) and the Bank of Japan (BoJ) are likely to extend their QE programs, de facto supporting negative interest rates. If- while the global economy is sliding into a mild recession – the Fed and the Bank of England (BoE) decided to raise rates in 1H-2016, they would likely cut them in 2H-2016 to avoid a full-blown recession (the bear case scenario highlighted in Table 1).
- … but further macro-liquidity injections are unlikely to support growth. The markets’ confidence in CB ability to repress volatility via accommodative policies will eventually decline. Going forward, additional policy stimulus will not be considered sufficient to address the weakening of global fundamentals. In a slowdown, companies will put investment and hiring on hold, households will save more.
- Net global imbalances are still unresolved. External imbalances are still there: since their pre-crisis peaks, current account imbalances (i.e. flow imbalances) have narrowed but not reversed (with the exception of the EZ). As a result, net external positions (i.e. stock imbalances) have widened. Additionally, the adjustment – by mostly relying on a reduction in demand in deficit economies – has increased internal imbalances (high unemployment and large output gaps). An abrupt, disorderly unwinding of global imbalances is a systemic risk and would bring about a significant market correction.
- An abrupt reduction of EM reserves could act as “global tightening”. In EMs, private capital outflows have increased significantly from USD 0.73tn in 2008 to USD 1.05tn in 2014, resulting in EM currencies depreciation. To support the exchange rate, CBs intervened and reduced their foreign exchange reserves by selling their DM-government bond holdings. This resulted in a reduction of total foreign exchange reserves of Brazil, Russia, India and China (BRIC) from USD 5.1tn (August 2014) to USD 4.6tn (August 2015). This process, defined as “quantitative tightening” (QT), rose to prominence in August. Were EMs to be hit by a financial crisis, QT could offset QE and result in a significant reversal of total CB support for global asset prices.
- Currency devaluations could hamper external balances … Between 2009 and 2015, led by monetary easing19, all major currencies – with the exception of the Chinese Yuan– experienced significant depreciation against the USD. Overtime, uncoordinated competitive devaluations (currency wars) aimed at supporting and boosting national economic activity could foster protectionism. In the same period, taking advantage of low interest rates in DMs, EM governments, banks and firms borrowed in USD at unprecedented levels: the total external debt of BRIC countries increased from USD 1.4tn in December 2008 to USD 2.3tn in December 2014. Once the Fed tightening cycle starts, the interest-rate differential between the US and EM economies will strengthen the USD and further weaken EM currencies, reducing the USD value of EMs domestic assets and causing breaches in loan covenants.
- … and USD strength squeeze EMs debt, and cause EM recession. US-denominated debt will, in sequence: a) become a bigger burden when measured in local currency; b) push international lenders to demand new collateral or loan repayment; c) impair local borrowers (governments, banks and firms)’s access to credit; and d) force these to allocate to debt servicing a larger share of their local-currency revenues. The higher demand for USD will foster further exchange-rate depreciation and further reductions in the USD value of the collateral. And so on: if a market-event (a Fed interest rates hike, a drop in commodity prices, a conflict) causes EM currencies to slide against the USD, the debt burden in local currency will rise even more: some borrowers will start missing interest payments and others will become unable to roll over principal. Reduced EM demand and imports will bring about a sharp growth deceleration, job creation will fall. A local recession will ensue, foreign lenders will withdraw their financing and domestic CBs will hike interest rates and intervene in the currency markets by selling reserves. Capital outflows from EMs – including China – will accelerate and create a global market turmoil.
E. Financial risks: rising probability of a market correction. An unstable equilibrium sooner or later gets disrupted. The system is fragile. Risk-events can be triggered in: 1) the real economy, where large debtors remain vulnerable to changes in market sentiment (see D. above); and 2) the markets, by periodic episodes of illiquidity. Increasingly, the market will question both the health of the global economy and the ability of CB policies to maintain financial stability, and will struggle to keep in equilibrium. Asset prices will eventually decline to match fundamentals; the risk of a market correction is rising.
- Volatility is increasing. CBs are increasingly unable to suppress volatility because: 1) the ongoing global deceleration is challenging the “low-growth equilibrium” of the past few years, which was instrumental in supporting and stabilizing asset prices; and 2) global monetary policy lacks coordination, fostering contagion across markets and asset classes. Even in the deep, liquid US markets, volatility has been rising steadily. The Chicago Board Options Exchange (CBOE) Volatility index (VIX), at 24.5, is 8 percent above the pre-crisis average of 20.8. Stocks and bonds volatility is rising.
- Financial stress is on the rise. Eventually, volatility will lower risk-propensity and trigger illiquidity events. The ECB’s Composite Indicator of Systemic Stress (CISS), at 0.156, is 110.8 percent above its pre-crisis average of 0.074. The Cleveland Financial Stress Index (CFSI), at 1.082 is 49 times above the pre-crisis average of 0.022. Only the Federal Reserve Bank of Louis’Financial Stress Index (SLFSI) reached a three year high of -0.521 on August 28, 2015, and, at -0.715, is 10 times below the pre-crisis average of 0.077.
- Macro-liquidity is not translating into consistent market-liquidity1. As showed by recent shocks – the markets are intrinsically illiquid because of: 1) cash hoarding: banks store liquidity by building excess reserves, and financial intermediaries hold liquid assets in anticipation of future losses from securities write-downs; 2) liquidity bifurcation:money is increasingly concentrating in ‘less liquid’ instruments (i.e. trade crowding); 3) large scale repositioning by leveraged investors in a context of asset concentration; 4) high-frequency trading (HFTs) via electronic algorithms, a system that – when many investors rush for the exit (herding behavior) – quickly drains liquidity; and 5) tighter regulatory constraintsand risk management have reduced the market-making activity of banks and other financial institutions.
- Markets are news-driven, upside-down. The implicit CBs guarantee has capsized the markets’ reaction. In other words, “good news” bring about a market correction (as they might entail a liquidity withdrawal) and “bad news” a rally (in the anticipation of further easing). Eventually, all news will be interpreted in a bearish way once: 1) CBs start the tightening cycle; or 2) the markets grow skeptical about the longer-term effectiveness of CBs policies.
- CB credibility at risk, policy mistakes likely. To avoid the risk of being perceived as having lost independence, CBs will soon have to face policy-exit challenges, such as: a)‘what intervention to discontinue first’ (sequencing); b) ‘when to exit’ (timing); and c) ‘by how much’ (size). These are all decisions that can lead to policy mistakes. Premature rate-hikes are an example: over the past six years, the majority of CBs that hiked rates – in chronological order, Norway, Israel, Chile, New Zealand, Sweden, Canada, South Korea, Brazil, Eurozone (EZ) and Australia – had to lower them again. In September, the Fed decision to postpone the announced rate hike weakened its future standing. Past experience has shown that credibility can be lost when policy decisions: 1) are perceived as mistakes by the markets; 2) are associated to a shock, leading to sharp price-drops, with spillovers in other markets; and 3) affect market expectations, i.e. the market stops believing in CB’s policy guidance or – worse – loses confidence on its effectiveness.
F. The recent episode of market volatility was an early-warning. For the markets to perform, a healthy global recovery and rising company earnings are needed. Yet, lower potential output growth, increased financial market volatility and a decline in asset prices remain important medium-term risks in both DMs and EMs. When risk-events materialize, global markets will expect quick CB intervention, and their interlocking will increase systemic fragilities and co-movements. In August 2015, China’s CNY devaluation was not followed by expeditious policy intervention: local authorities waited about 15 days before they reduced risk by taking important liquidity measures, and global markets tanked.
- When CBs start tightening, a correction will ensue. In the medium term, a correction is inevitable. Liquidity withdrawal, in absence of sustained growth will bring the top line (prices) to adjust to the bottom line (real economy). Tightening will bring about lower growth and higher unemployment. The debt accumulated during the “easy-money period” will proof difficult to pay back, and credit restrictions will bring about a decline in equities.
- The correction will take place in an environment of impaired market-liquidity1. Once macro-liquidity is withdrawn at the global level, market illiquidity will eventually bring about a cyclical bear market (-20 percent, at least) and CBs will be unable to intervene. In the bond markets, because of regulatory reasons banks and brokers will be unable to act as bond-market intermediaries, absorbing volatility – as they did in the past (see E. 1. and 3. above).
- Economic interdependencies increase risks. Interconnection increases risks rather than diminishing them. Examples abound. Importantly, the unwinding of global imbalances can work as a “crisis-transmission-mechanism”. Over the past six years, EMs – forced to invest their reserves in large liquid debt markets – financed deficits in large DMs, with BRIC countries holding of US sovereign debt increasing from USD 1tn (December 2008) to USD 1.7tn (December 2014).
G. Where to invest? With respect to the past decades, investors face a very different, and more difficult, investment environment. The market seems to have moved ahead of fundamentals, and a correction looks likely. The probability of future financial shocks, and black swans, is high. Capital preservation via a defensive asset allocation is priority. Yet, unusual portfolios – less liquid and more volatile – are likely to perform better than conventional ones.
- In the equity markets, taking fundamental directional bets (i.e. via long-only funds) is likely to prove disappointing: earnings growth will soften, especially in EMs; financials are likely to suffer. Investors will privilege strong balance sheets and value. Blue chips income-producing multinational brands will do well, as a significant share of their revenues is linked to the rise of the EM middle-class. Small luxury companies, healthcare providers (including insurance and pharmaceuticals) and the consumer sector are likely to generate returns. US stock markets are likely to outperform.
- In the bond markets, core sovereign bonds (UST and German Bunds) might benefit from risk-off episodes, slowing economic growth and a further reduction in long-term interest rates. Still, in absence of systemic shocks, high-yield corporate credit might perform well and EM bonds denominated in local currencies could deliver even higher returns. Inflation-linked bonds show more risk than returns.
- Illiquid assets, such as private equity and real estate are to be considered, but only if fully understood, properly priced and professionally executed. Upcoming macroeconomic conditions (growth deceleration, subdued inflation, distressed valuations) will create entry-price opportunities in most sectors. Technology – e.g. efficiency-enhancing management systems, bio-technology, robotics – remains an obvious choice.
- Commodities’ abundant supply and weak demand are likely to bring about moderate returns. Low global inflation and USD strengthening will remain headwinds for performance. Commodity prices are at nearly unprecedented lows: the CRB Commodity Index is at the same level it was in the 1970s.
- Over the next couple of years, cash could work as both an insurance against sharp downturns and the required seeding-capital to quickly size opportunities. Still, in the longer-run keeping liquid portfolios will result in low returns.
- In the currency markets, ECB monetization should weaken the EUR. If a tail risk materializes, investors will retreat to the USD, the world’s primary trading and reserve currency and global safe haven. The Swiss franc (CHF) is likely to maintain its purchasing power.
The indicative portfolio shown here below attempts to crystallize the above.
Table 2. Asset allocation
Source: Author’s elaboration, 2015.
I thank Francisco Quintana, Pablo Gallego Cuervo and Mert Yildiz for their comments and suggestions, PulsarKC for data collection. All errors are mine.
 Definition of “macro-liquidity”: broad money supply. Definition of “market-liquidity” (i.e. trading liquidity): ability to execute large financial transactions in a short time, with minimal transaction costs and limited impact on asset prices.
Note: *Nominal GDP growth (in USD) and inflation data are for the period January 1, 2009 to December 31, 2014. ** Performance from March 1, 2009 until September 30, 2015. Stocks – World: Dow Jones Global Index; US: Dow Jones Industrial Average (DJIA); EZ: EuroStoxx 600; Japan: Nikkei 225; Brazil: IBOVESPA; Russia: MICEX; India: Nifty; China: Shanghai Composite. Bonds – World: JPM Global Aggregate Bond Index. Commodities – Rogers International Commodity Index (a composite USD based total return index – RICI). Source: Bloomberg, Reuters 2015.
Source: Author’s elaboration on Bloomberg, Reuters and IMF, 2015.
Note: CAGR mean annual growth rate that provides constant rate of return over 2009-2015. *Real GDP growth (in USD) and inflation data are for the period January 1, 2009 to December 31, 2014. ** Performance from March 1, 2009 until September 30, 2015. Stocks – World: Dow Jones Global Index; US: DJIA; EZ: EuroStoxx 600; Japan: Nikkei 225; Brazil: IBOVESPA; Russia: MICEX; India: Nifty; China: Shanghai Composite. Bonds – World: JPM Global Aggregate Bond Index. Commodities – Rogers International Commodity Index (a composite USD based total return index – RICI). \** Performance from January 1, 2010 until September 30, 2015. US Bonds – Bloomberg US Treasury Bond Index; EZ (proxy): Bloomberg Germany Sovereign Index; Japan: Bloomberg Japan Sovereign Bond Index; Brazil: Bloomberg Brazil Sovereign Bond Index; Russia: Bloomberg Russia Sovereign Bond Index (note: performance from March 1, 2009 until September 30, 2015); India: Bloomberg India Sovereign Bond Index; China: Bloomberg China Sovereign Bond Index. Source:* Bloomberg, Reuters 2015.
 Over 2009-14, unemployment rates declined in both DMs and EMs. In the US, the unemployment rate reached a peak of 10.0 percent in October 2009, falling to 5.1 percent in August 2015 – the lowest level since August 2008. In the EZ, the unemployment rate reached a peak of 12.1 percent in April 2013, falling to 10.9 percent in July 2015, the lowest level since January 2012. In Japan, the unemployment rate reached a peak of 5.6 percent in July 2009, falling to 3.3 percent in April 2015, the lowest level in nearly two decades. In Brazil, the unemployment rate reached a peak of 9.0 percent in March 2009, falling to 4.3 percent in December 2014, the lowest level since December 2013. In Russia, the unemployment rate reached a peak of 9.4 percent in February 2009, falling to a record low of 4.8 percent in August 2014. In India, the unemployment rate reached an all-time high of 9.4 percent in 2009, falling to a record low of 4.9 percent in 2013. In China, the unemployment rate reached a peak of 4.3 percent in Q1 2009, falling to 4.0 percent in Q3 2013, the lowest level since Q3 2008. Source: Trading Economics, 2015.
 Globally, inflation is at its lowest levels since the early 1960s. In 2015, in 189 countries across the world, median inflation is below 2 percent (CBs’ definition of price stability), slightly lower than in 2014. In the US, inflation reached a peak of 3.9 percent year-on-year (yoy) in September 2011 and fell to -0.2 percent yoy in April 2015, the lowest level since Jul 2009. In the EZ, inflation reached a peak of 4 percent yoy in June 2008, falling to -0.6 percent yoy in January 2015, the lowest level since July 2009. In Japan, inflation reached a peak of 3.7 percent yoy in May 2014, falling to 0.2 percent yoy in July 2015, the lowest level since June 2013. In Brazil, inflation spiked in recent months to the highest in nearly a decade, reaching 9.6 percent yoy in July 2015, up from 6.4 percent yoy in December 2014. In Russia, inflation has increased sharply since Q4 2014, to levels last seen in 2002: it reached a peak of 16.9 percent yoy in March 2015, from 8.0 percent yoy in Sep 2014. In India, inflation reached an all-time high of 11.2 percent yoy in November 2013, falling to a record low of 3.8 percent yoy in July 2015. In China, inflation reached a peak of 6.5 percent yoy in July 2011, falling to 0.8 percent yoy in January 2015, the lowest level since November 2009. Source: Trading Economics, 2015.
Note: * Performance from August 11, 2015 until September 30, 2015. Stocks – World: Dow Jones Global Index; US: Dow Jones Industrial Average (DJIA); EZ: EuroStoxx 600; Japan: Nikkei 225; Brazil: IBOVESPA; Russia: MICEX; India: Nifty; China: Shanghai Composite. Bonds – World: JPM Global Aggregate Bond Index. Commodities – Rogers International Commodity Index (a composite USD based total return index – RICI). Source: Bloomberg, Reuters 2015.
 The S&P 500 Index is at about 16 times its expected (next 12 months) earnings, below the 2015 peak (17.8) but above the historic mean (about 15). US: As of end-Sept 2015, the PE on the DJIA index was 14.2, 25.8 percent below the pre-crisis average of 19.1. EZ: As of end-Sept 2015, the PE on the Eurostoxx 600 was 20.5, 11.9 percent below the pre-crisis average of 23.3. Japan: As of end-Sept 2015, the PE on the Nikkei 225 was 18.4, 53.4 percent below the pre-crisis average of 39.5. Brazil: As of end-Sept 2015, the PE on the Ibovespa index was 26.6, 67.5 percent above the pre-crisis average of 15.9. Russia: As of end-Sept 2015, the PE on the MICEX index was 9.5, 3.8 percent below the pre-crisis average of 9.9. India: As of end-Sept 2015, the PE on the NIFTY index was 20.4, 25.0 percent above the pre-crisis average of 16.3. China: As of end-Sept 2015, the price-to-earnings ratio (PE) on the Shanghai Composite index was 15.3, 57.8 percent below the pre-crisis average of 36.2. Source: Bloomberg, 2015.
 For a methodological clarification on how the amount is calculated, see Endnotes 12 and 15. This unprecedented amount of resources was spent to: 1) sustain the economy; 2) support the labor markets; and 3) stabilize the financial markets by facilitating assetpurchases or sales without drastic changes in their price.
 Between 2008 and 2014, most governments’ debt-to-GDP ratios rose significantly (with the exception of India): in the US, from 72.8 (2008) to 104.8 percent (2014); EZ: from 68.6 to 94.0 percent; Japan: from 191.8 to 246.4 percent; Brazil: from 61.9 to 65.2 percent, Russia: from 8.0 to 17.9 percent, India: from 74.5 to 65.0 percent; China: from 31.7 to 41.1 percent. Note: The debt-to-GDP ratio is calculated as “general government gross debt as a percentage of GDP”. Source: IMF, 2015.
 The total fiscal stimulus is calculated as the change in total government debt from 2008-14 for US, EZ, Japan, UK, Switzerland and BRIC. In the US, total debt rose from USD 10.7tn (2008) to USD 18.2tn (2014). In the EZ, from USD 9.7tn (2008) to USD 12.6tn (2014). In Japan, from USD 8.0tn (2008) to USD 10.0tn (2014). In the UK, from USD 1.2tn (2008) to USD 2.5tn (2014). In Switzerland, from USD 0.29tn (2008) to USD 0.30tn (2014). In Brazil, from USD 0.7tn (2008) to USD 1.3tn (2014). In Russia, from USD 0.06tn (2008) to USD 0.2tn (2014). In India, from USD 0.7tn (2008) to USD 1.3tn (2014). In China, from USD 1.6tn (2008) to USD 4.3tn (2014). Source: IMF, 2015.
 In most DMs, policy interest rates are near zero (and sometimes below it). US: Starting in September 2007, in a series of 10 moves, the Fed reduced the federal funds target from 5.25 percent to the range “from 0 to 0.25 percent” on December 16, 2008, where it has remained since. EZ: Starting in October 2008, in a series of 7 moves, the ECB’s benchmark refinancing rate was reduced from 4.25 percent to 1.0 percent in May, 2009. Further in a series of 5 moves beginning in Jul 2012, the rate was reduced to 0.05 percent in September 2014, where it has remained ever since. Japan: Starting in October 2008, the BoJ cut its policy rate in two moves from 0.5 percent to 0.1 percent in December, 2008. In October 2010, BOJ announced that it would maintain the interest rate range “between 0 percent and 0.1 percent”. UK: Starting in October 2008, in a series of 6 moves, the Bank of England (BoE) reduced the benchmark bank rate from 5.0 percent to 0.5 percent in March 2009, where it has remained since. Switzerland: Starting in October 2008, in a series of 4 moves, the Swiss National Bankreduced its benchmark deposit interest rate from 2.75 percent to 0.25 percent in March 2009. In August 2011, the bank reduced its interest rates to zero. Beginning in December 2014, the bank further cut its interest rates, in two steps, to a record low of -0.75 percent in January 2015, where it has remained ever since. China: Between September 2008 and December 2008, in a series of 4 moves, the PBoC cut its benchmark lending rate from 7.2 to 5.3 percent. Between February and August 2015, a slowing economy forced the PBOC to undergo another round of interest rate cuts, from 5.6 to 4.6 percent in a series of 4 moves. Source: Trading Economics and CEIC, 2015.
 The world’s main CBs have expanded their balance sheets significantly: in the US, from USD 2.2tn (December 2008) to USD 4.5tn (December 2014); in the EZ, from USD 2.4tn (December 2008) to USD 2.7tn (December 2014); in Japan, from USD 1.0tn (December 2008) to USD 2.5tn (December 2014); in the UK, from USD 0.3tn (December 2008) to USD 1.2tn (December 2014); in Switzerland, USD 0.2tn to USD 0.6tn; in Brazil, from USD 0.4tn (December, 2008) to USD 0.8tn (December, 2014); in Russia, from USD 15.8bn (December 2008) to USD 23.7bn (December 2014); in India, from USD 0.1tn (December 2008) to USD 0.2tn (December 2014); in China, from USD 3.4tn (December 2008) to USD 5.5tn (December 2014). Source: Trading Economics, 2015
 The total monetary stimulus is calculated as the increase in the globe’s main CBs’ balance sheet size, from December 2008 to December 2014 (see Endnote 14). In most DMs, the monetary base (money created by CBs in the form of cash and liquid commercial-bank reserves) has soared – quadrupling in the United States – relative to the pre-crisis period. Source:Trading Economics, IMF, 2015.
 After initiating spending cuts in intermediate years, most governments (except US and India) have increased their total expenditure as a percentage of GDP from 2008 to 2014: US: from 37.2 percent (2008) to 36.8 percent (2014); EZ: from 46.3 percent (2008) to 49.4 percent (2014), after cutting expenditures by 1.7 percent of GDP during 2009-11; Japan: from 35.7 percent (2008) to 40.3 percent (2014), after cutting expenditures by 1.1 percent of GDP during 2009-10 and by 0.7 percent during 2011-12; Brazil: from 37.4 percent (2008) to 40.2 percent (2014), after cutting expenditures by 1.2 percent of GDP during 2010-11; Russia: from 34.3 percent (2008) to 38.3 percent (2014) after cutting expenditures by 5.6 percent of GDP during 2009-11; India: from 29.7 percent (2008) to 26.5 percent (2014); China: from 22.7 percent (2008) to 29.6 percent (2014). Similarly, fiscal deficits as a percentage of GDP have grown for most governments (except US and India) after reductions in intermediate years: US: from 7.0 percent (2008) to 5.3 percent (2014); EZ: from 2.1 percent (2008) to 2.7 percent (2014); Japan: from 4.1 percent (2008) to 7.7 percent (2014), after reducing the deficit by 1.1 percent of GDP during 2009-10; Brazil: from 1.5 percent (2008) to 6.2 percent (2014), after reducing the deficit by 0.7 percent of GDP during 2009-11; Russia: from 4.9 percent surplus (2008) to 1.2 percent deficit (2014), after reducing the deficit by 7.8 percent of GDP during 2009-11; India: from 10.0 percent (2008) to 7.1 percent (2014); China: from -0.03 percent (2008) to -1.1 percent (2014), after reducing the deficit by 2.3 percent of GDP during 2009-11. Source: IMF, 2015.
 The Fed has signaled that it will begin raising interest rates when the economy gets closer to full employment. The ECB has maintained its interest rates at 0.05 percent and has hinted at further expansion of the QE program in a press conference on September 3, 2015. The BOJ has maintained its interest rates near 0 percent and analysts expect the bank to expand its monetary stimulus in Q4 2015, in an attempt to get inflation close to its 2 percent target. Together, the QE programs of ECB and BOJ are adding USD 130bn a month to global liquidity. However, the impact of QE will not be as pronounced as witnessed earlier, as EM CBs are drawing on their reserves (primarily by selling DM sovereign bonds) in a bid to support their falling currencies. As per Fulcrum estimates, EM balance sheets may have declined by USD 450bn over the last three months due to this intervention. Source: Trading Economics, Fulcrum and CEIC, 2015.
 Between March 1, 2009 and September 30, 2015, total market capitalization rose in the US (DJIA Index): from USD 2.2tn to USD 4.9tn; in the EZ (Eurostoxx 600): from USD 5.0 to USD 10.1tn; in Japan (Nikkei 225): from USD 1.6 to USD 2.7tn; in Brazil (IBOVESPA): from USD 0.35 to USD 0.4tn; in Russia (MICEX): from USD 0.2 to USD 0.4tn; in India (NIFTY): from USD 0.3 to USD 0.8tn; in China (Shanghai Composite): from USD 1.6 to USD 4.0tn. Source: Bloomberg, 2015.
 CBs embarked in open market operations involving the purchase and sale of Treasury securities, a practice referred to as QE. Coupled with low interest rates, QE freed up capital and encouraged in risk appetite amid ultra-supportive monetary policy. As a guaranteed purchaser of assets, CBs gave confidence to bond investors. Bond-buying helped bring down governments’ borrowing costs. Weaker inflation lead to mounting calls for another round of QE. US: the Fed pioneered QE, an unconventional monetary stimulus through unsterilized purchases of Treasury and mortgage-backed securities (MBS). Between 2009 and 2014, the Fed undertook three rounds of QE. The third round was completed in October 2014, at which point the Fed’s balance sheet was USD4.5tn, five times its pre-crisis size. Overall, the Fed’s balance sheet expanded from USD2.2tn (December 2008) to USD4.5tn (December 2014). EZ: In January 2015, the ECB announced a EUR 1.1tn QE scheme under which it would buy EUR 60bn of EZ government bonds each month. Overall, ECB’s balance sheet expanded from USD2.4 (December 2008) to USD2.7tn (December 2014). Japan: in April 2013 the BoJ launched its QE program for purchase of government bonds and expanded it in October 2014, to increase its holdings at an annual pace of JPY 80tn. Overall, BoJ’s balance sheet expanded from USD 1.0 (December 2008) to USD2.5tn (December 2014). UK: Between March and November 2009, the BoE decided to purchase Pound Sterling (GBP) 200 billion of financial assets (mostly UK Government debt or ‘gilts’). Since then the CB has decided on further purchases: GBP 75bn in October 2011; GBP 50bn in February 2012 and GBP 50bn in July 2012, bringing total assets purchases to GBP 375 bn. Overall, BoE’s balance sheet expanded from USD 0.3 (December 2008) to USD 1.2tn (December 2014). Brazil:Banco Central Do Brasil (BCB) expanded its balance sheet from USD0.4 (December 2008) to USD0.8tn (December 2014). Russia:Central Bank of Russia (CBR)’s balance sheet expanded from USD15.8 (December 2008) to USD23.7bn (December 2014). India:Reserve Bank of India (RBI)’s balance sheet expanded from USD0.1 (December 2008) to USD0.2tn (December 2014). China: between January and Aug 2015, the PBoC induced further liquidity in the markets by cutting its bank reserve requirements, from 20 to 18 percent. Overall, PBOC’s balance sheet expanded from USD3.4 (December 2008) to USD5.5tn (December 2014). Across the world, money-printing brought about currency depreciation, or outright devaluation (via administrative decision – mostly in Asia so far). QE programs by the ECB and Bank of Japan (BoJ) have played a crucial role in depreciation of Euro (EUR) and Japanese Yen (JPY) respectively. Source: Trading Economics, 2015.
 YTD performance for major commodities (until September 30, 2015): RICI (benchmark): -14.7 percent; Brent (USD per bbl): -14.7 percent; Gold (USD per oz): -6.1 percent; Copper (USD per mt): -14.2 percent; Aluminum (USD per mt): -11.0 percent and Corn (USD per bu): -5.4 percent. Source: Reuters, 2015.
 Healthy banks and corporations are on hold, lacking confidence to make significant business and investment decisions, since sales, profit margins and corporate earnings might suffer. Commercial banks, slow to heal from the 2008-crisis, crowded out private-sector credit. With slow economic growth, revenue and corporate earnings stagnate.
 On the supply side, years of weak demand brought about a decline in potential output. On the demand side, in many countries aggregate demand is weak because of investment cuts, resulting in lower exports from current account surplus countries, such as China and Germany. On the policy side, liquidity injections helped government and firms refinance their debt and pay less in interest. After nearly seven years of almost-zero interest rates, minimal inflation is reducing most business’ pricing power. Household, financial-sector and public-sector deleveraging brings about disinflation or outright deflation, buyers anticipate lower prices and consumption declines. In other words, monetary policy put a “stop loss” to the recession but it has not created the 3-and-above percent growth needed to spur inflation.
 Retail sales are performing better than in 2009, when they suffered a 0.6 percent yoy contraction. US: retail sales increased by 4.3 percent yoy in 2009 and by 3.3 percent yoy in 2014. EZ: retail sales declined by 1.0 percent yoy in 2009 but increased 3.0 percent yoy in 2014. Japan: retail sales witnessed a -0.2 percent decline in 2009 but grew marginally by 0.1 percent in 2014. Brazil: retail sales increased by 12.0 percent yoy in 2009 and 6.0 percent yoy in 2014. Russia: retail sales declined by 3.2 percent yoy in 2009 but increased 5.1 percent yoy in 2014. China: retail sales growth slowed from 17.5 percent yoy in 2009 to 11.9 percent yoy in 2014, Source:Statista, Bloomberg, Trading Economics, 2015.
 In 2016, China’s real GDP growth will decelerate further: given debt levels and excess capacity, a reduction in fixed investment (infrastructure, construction and manufacturing activities) as a share of GDP is inevitable, and will inevitably hamper aggregate demand. Infrastructure spending, mostly funded by local government debt, will suffer fiscal consolidation. Construction will suffer an abundant housing supply, especially in secondary cities, and the main developers’ inability to access funding. In manufacturing, heavy industries suffer from large excess capacity. As in 2014 China accounted for 13.3 percent of world GDP, and 14.3 percent of global trade, DMs will suffer knock-on effects. EMs will be affected, as they either directly trade with China or export to countries that trade with China.
 Several of the world’s largest EMs are already in recession and struggling to revive growth, especially those reliant on commodity exports. Going forward, some EMs are bound to export less to stagnating DMs, some commodity-intensive exporters will export less to China. Lower commodity prices also pose risks to the outlook in low-income developing economies. Both Brazil and Russia will suffer a recession in 2015, with the Brazilian economy expected to contract at -1.5 percent and the Russian economy at -3.7 percent. The Indianeconomy is expected to grow at 7.4 percent. A weaker outlook is likely in countries with significant USD-denominated debts and those most dependent on Chinese demand for their exports. China’s slowdown might be faster than the government wishes, as the economic growth for this year is expected to slow to 6.7 percent. China matters: Over the past 10 years (from 2005 until 2015), China has accounted for a third (32.4 percent) of the expansion in the global economy, compared with 18.4 percent from the US. The contribution from the other large economies—Europe’s and Japan’s—has fallen to less than 10 percent. Most EMs remain fragile: while, since 2010, many economies have accumulated large international reserves – to self-insure against a run on their currencies or their foreign debt – in the majority of them short-term debt constitutes 50 percent or more of the stock of international reserves. Source: IMF, 2015.
OECD area: the CLI was at 100.1 in June 2015, up from 96.2 in end-2008. US: the CLI declined from 100.2 in end-2014 to 99.6 in June 2015 (95.6 in end-2008). EZ: CLI increased from 100.4 in end-2014 to 100.7 in June 2015 (up from 96.7 in end-2008). Japan: CLI increased from 99.9 in end-2014 to 100.0 in June 2015 (97.5 in end-2008). In major EMs the CLI is below 100. Brazil: CLI declined from 100.0 in end-2014 to 98.9 in June 2015 (95.4 in end-2008). Russia:CLI declined from 99.7 in end-2014 to 98.9 in June 2015 (91.8 in end-2008). India: CLI increased from 99.2 in end-2014 to 99.7 in June 2015 (99.0 in end-2008). China: CLI declined from 98.8 in end-2014 to 97.9 in June 2015 (92.9 in end-2008). Source:OECD, 2015.
US: the CB LEI for increased from 99.5 in end-2008 to 123.7 in August 2015. EZ: CB LEI increased from 93.3 in end-2008 to 108.0 in August 2015. Japan: CB LEI increased from 103.2 in end-2008 to 104.2 in August 2015. Brazil: CB LEI declined from 126.5 in end-2008 to 87.7 in August 2015. India: CB LEI declined from 175.7 in end-2008 to 102.8 in Aug 2015. China: CB LEI increased from 144.5 in end-2008 to 334.4 in August 2015. Source: The Conference Board, 2015.
US: ISM Manufacturing PMI stood at 51.1 in August 2015 versus 33.1 in December 2008, the lowest level since the financial crisis. EZ:Manufacturing PMI stood at 52.0 in September 2015 vs 33.9 in December 2008 and 33.5 in February 2009, the lowest level since the financial crisis. Japan:Manufacturing PMI stood at 51.0 in September 2015 vs 36.7 in December 2008 and 29.6 in February 2009, the lowest level since the financial crisis. Brazil:Manufacturing PMI, at 45.8 in August 2015, was at four-year low vs 48.5 in June 2012. Russia:Manufacturing PMIstood at 49.1 in September 2015 vs 50.0 in September 2011 and a record-low of 47.6 in January 2015. India:Manufacturing PMI fell to seven-month low of 51.2 in September 2015 vs 54.9 in March 2012 and a record-low of 48.5 in August 2013. China:Manufacturing PMIdropped to record-low of 47.2 in September 2015 vs 48.7 in October 2011. Source: Bloomberg, Trading Economics, 2015.
 The decline is not as steep as during the past crisis (- 21.5 percent in 2009) but it is globally widespread and more pronounced in EMs. US: merchandise exports declined by 5.2 percent yoy in H1 2015 vs a 18.0 percent yoy decline in 2009. EZ: merchandise exports declined by 14.8 percent yoy in H1 2015 vs a 22.4 percent yoy decline in 2009. Japan:merchandise exports declined by 8.1 percent yoy in H1 2015 vs a 25.7 percent yoy decline in 2009. Brazil: merchandise exports declined by 14.7 percent yoy in H1 2015 vs a 22.7% yoy decline in 2009. Russia: merchandise exports witnessed a sharp decline (down 28.5 percent yoy in H1 2015 vs a 35.7 percent yoy decline in 2009) due to slump in oil prices. India:merchandise exports declined by 16.2 percent yoy in H1 2015 vs a 15.4 percent yoy decline in 2009. China: merchandise exports remained flat in H1 2015 vs a 15.0 percent decline in 2009.
US: existing home sales fell to 3.5 million units in July 2010 but reached 5.6 million units in July 2015, the highest level since 2007. In August, existing home sales declined marginally to 5.3 million units. Japan: sales of condominiums in Tokyo increased from 25,378 units in 2009 to 33,750 units in 2014. Brazil: residential units sold in São Paulo declined from 34,719 units in 2009 to 20,595 units in 2014. Russia: annual construction of residential housing increased from 59.9 million (mn) square meters (sqm) in 2009 to 65.7 mn sqm in 2012. China: floor space of residential buildings increased from 852.9 mn sqm in 2009 to 1,051.8 mn sqm in 2014. Source: Bloomberg, Trading Economics, 2015.
 At 96.0 in Q2 2015, it was higher than during the financial crisis (77.0 in Q1 2009). However, in most economies the CCI indicates pessimism. US: the CCI is at 87.2 (September 2015) versus 77.0 at the end of 2008 and its record-low of 56.3 in February 2009. EZ: CCI stood at -7.1 in September 2015 (vs -31.0 in end-2008 and record-low of -34.3 in March 2009), below its neutral score of 0.0. Japan:CCI stood at 41.7 in August 2015 (vs 27.6 in end-2008 and its record-low of 27.4 in January 2009), below the neutral score of 50.0. Brazil:CCI declined from 109.8 in end-2008 to a record-low of 96.2 in June 2015 before inching up to 98.9 in August 2015. Russia:CCI declined from -20.0 in end-2008 to a record-low of -37 in April 2009 before moving up to -23.0 in June 2015 (the neutral score is 0.0). India and China are the only major economies with optimistic consumer sentiments. India:CCI increased from 120.0 in end-2008 to 131.0 in July 2015. China: CCI increased from 101.8 in end-2008 to 104.0 in August 2015. Source: Trading economics, 2015.
 The definition of “global recession” has evolved over the years. Until 2009, the IMF did not have an official definition but informally used the 3 percent benchmark in a number of papers and communications. The 2009 WEO (page 11 box 1.1) provided the following definition: “A decline in annual per‑capita real World GDP (purchasing power parity weighted), backed up by a decline or worsening for one or more of the seven other global macroeconomic indicators: Industrial production, trade, capital flows, oil consumption, unemployment rate, per‑capita investment, and per‑capita consumption.”.
 The current level of corporate debt in DMs stands at USD 16.4tn and in EMs at USD 2.9tn. Government debt in DMs has increased from USD 29.9tn (2008) to USD 43.6tn (2014) and in EMs, it has increased from USD 3.1tn (2008) to USD 7.1tn (2014). External debt in DMs has increased from USD 18.8tn (Dec, 2008) to USD 24.3tn (Dec, 2014) and in EMs, it has increased from USD 1.4tn (December 2008) to USD 2.3tn (Dec, 2014). In DMs, the US and the EZ have the highest amounts of outstanding corporate debts with US corporate debt at USD 7.0tn and EZ corporate debt at USD 8.7tn, followed by Japan at USD 0.7tn. Among BRIC economies, China has the highest corporate debt of USD 2.3tn, followed by India: USD 0.3tn, Brazil: USD 0.2tn, Russia: USD 0.1tn. For government debt levels in DMs and EMs refer to endnote 10, and for external debt levels refer to endnote 50. Source: Bloomberg, 2015.
 To grow there is the need to invest (Europe and USA) and to change development model, i.e. the composition of GDP (China, Turkey, several EMs, even Japan). Across most DMs, governments should encourage household consumption and corporate investment in plants, equipment and people.
 The US economy is vulnerable to the global economic slowdown. The September 2015 jobs report shows that the economy added 142,000 jobs, well-below the 200,000 expected by the markets. Private payrolls increased by 118,000, about the minimum level for unemployment not to rise. Government payrolls added 24,000. August was revised down by 37,000 jobs, and July by 22,000. The last three months have averaged 167,000 new jobs, the previous three months 231,000 and the six prior months 260,000. The unemployment rate remained at 5.1 percent, largely because of a drop in labor participation. For Q3-2015, the Atlanta Fed estimates real GDP at 0.9 percent. In the US energy sector, some of the weakest companies were heavy borrowers with a significant amount of high-yield paper outstanding.
 EMs contribute a bigger share of global GDP growth than DMs, when measured by purchasing power parity (PPP). When calculated by PPP, which accounts for exchange rate changes, DMs account for 39 percent of global GDP growth, down from 54 per cent in 2004. Source: IMF, 2015.
 The only policy tool seems to be a major injection of fiscal spending financed by CBs unconventional measures. CBs would have to extend bond purchases or bring interest rates into negative territories, policies still untested and that would put financial stability at risk.
 In August 2015, the downward trend in Chinese markets was accentuated by the PBOC’s hesitant policy responses. In September, a few EM central bankers denounced that uncertainty over Fed policy has increased capital outflows, depreciated currencies and destabilized stock markets; they urged the US Federal Reserve to raise rates sooner rather later. At the same time, most analysts feared that a Fed hike could trigger financial panic, tighten financial conditions, further destabilize EMs and hamper the global and US economy, and it would have to be reversed in the near future.
 Global imbalances had increased due to complex factors such as growth differential (i.e. faster growth attracts more capital inflows), demographics, government debt, financial depth and the exchange rate – productivity developments, shocks to portfolio preferences, bubbles in asset prices, shifts in fiscal policy, and increased desired saving in EMs.
 Current account deficit for the US has almost halved from 4.7 percent in 2008 to 2.4 percent in 2014. EZ economies, which had a current account deficit of 1.7 percent in 2008, now have a current account surplus of 2.3 percent. Current account surplus in Japan has reduced drastically from 2.9 percent in 2008 to 0.5 percent in 2014. Among the emerging economies, Brazil’s current account deficit has widened from 1.7 percent in 2008 to 3.9 percent in 2014. Current account surpluses for Russia and China have narrowed significantly (Russia: 6.3 percent in 2008 to 3.1 percent in 2014 and China: 9.2 percent in 2008 to 2.0 percent in 2014). India’s current account deficit has narrowed from 2.3 percent in 2008 to 1.4 percent in 2014. Source: IMF, 2015.
US has transformed from a net lender in 2008 to a net borrower in 2014, with net foreign assets to GDP ratio declining from 1.9 percent in 2008 to -2.5 percent in 2014. Other major developed economies remain net lenders, with net foreign assets to GDP ratio for EZ rising from 26.6 percent in 2008 to 28.2 percent in 2014, and Japan from 18.8 percent in 2008 to 26.8 percent in 2014. Major emerging economies also remaining net lenders led by China, with net creditor position at 45.1 percent of GDP in 2014 (although it has declined from 57.3 percent in 2008). Net foreign asset to GDP position for other BRIC economies has also remained positive- Brazil: 11.2 percent of GDP in 2014 (8.6 percent of GDP 2008); Russia: 23.9 percent of GDP in 2014 (24.9 percent of GDP in 2008); India: 14.9 percent of GDP in 2014 (19.5 percent of GDP in 2008). Source: World Bank, 2015. Note: Net foreign assets and GDP for EZ have been calculated by taking the sum of corresponding values for all EZ countries.
 To support the real economies, CB lowered interest rates to increase interest-sensitive spending, such as business capital spending on plant and equipment, household spending on consumer durables, and residential investment. However, this monetary policy channel did not stimulate aggregate spending. CBs’ interventions became ineffective because of liquidity hoarding for commercial banks rather than channeling it on to other banks and the real economy. This brought about the inability of massive liquidity injections by CBs to fully restore interbank activity. After six years of demand weakness, the likelihood of damage to potential output is increasingly a concern.
Brazil: private capital outflows increased from USD1bn in 2008 to USD44bn in 2014. Russia: private capital flows declined from USD239.5bn in 2008 to USD127bn in 2014. India:private outflows declined from USD23.7bn in 2008 to USD17.2bn. China: the country registered a steep increase in private capital outflows, from USD144.4bn in 2008 to USD383.9bn in 2014.
 DMs hold less foreign exchange reserves than EMs. In 2015, DMs held USD3.97tn, compared with USD7.52tn for EMs. Most of EMs (with exception of India) have witnessed a reduction in their foreign exchange reserves over the last year: Brazil: USD 379.2bn (August 2014) to USD 368.2bn (August 2015); Russia: USD 465.2bn (August 2014) to USD 366.3bn (August 2015); India: USD 318.6bn (August 2014) to USD 352.0bn (August 2015); China: USD 3968.8bn (August 2014) to USD 3557.0bn (August 2015). Source: Trading Economics, IMF, 2015.
 In 2015, the BoJ and the ECB are purchasing bonds (and expanding their balance sheet) at an average of about USD130 billion a month. In August alone, EM foreign exchange intervention was around USD160 billion. Just in China, to stabilize its currency after the August 11 CNY devaluation the PBoC sold about USD106 billion of reserve assets. Source: Fulcrum, Bloomberg, 2015.
 From March 1, 2009 until September 30, 2015, the USD index rose by 8.0 percent (89.0 to 96.1), the Euro depreciated by 10.8 percent (1.3 EUR/USD to 1.1 EUR/USD), JPY depreciated by 23.4 percent (97.2 USD/JPY to 120.0 USD/JPY), Brazilian Real (BRL) depreciated by 66.9 percent (2.4 USD/BRL to 4.1 USD/BRL), Russian Rouble (RUB) depreciated by 82.2 percent (36.2 USD/RUB to 65.9 USD/RUB) and Indian Rupee (INR) depreciated by 26.9 percent (51.8 USD/INR to 665.7 USD/INR). While, CNY appreciated by 7.1 percent (6.8 USD/CNY to 6.4 USD/CNY). The currencies of Malaysia, Indonesia, South Africa, Turkey, Colombia, Chile, and Mexico have been repeatedly hitting record lows. From March 1, 2009 until Sept 30, 2015, the Malaysian Ringgit(MYR) depreciated by 18.7 percent (3.7 USD/MYR to 4.4 USD/MYR), hitting 17-year low of 4.5 USD/MYR on Sept 29, 2015; Indonesian Rupiah (IDR) depreciated by 22.4 percent (11985 USD/IDR to 14655 USD/IDR), hitting 17-year low of 14,715 USD/IDR on Sept 29, 2015; South African Rand (ZAR) depreciated by 31.9% percent (10.5 USD/ZAR to 13.9 USD/ZAR) and hit a record low of 14.0 USD/ZAR on Sept 7, 2015; Turkish Lira (TRY) depreciated by 75.3 percent (1.7 USD/TRY to 3.0 USD/TRY) and hit low of 3.06 USD/TRY on Sept 14, 2015; Colombian Peso (COP) depreciated by 19.3 percent (2588.1 USD/COP to 3,088.7 USD/COP) and hit a record low of 3243.1 USD/COP on Aug 26, 2015; Chilean Peso (CLP) depreciated by 15.0 percent (605.9 USD/CLP to 697.0 USD/CLP) and hit a record low of 706.7 USD/CLP on Aug 26, 2015; Mexican Peso (MXN) depreciated by 10.2 percent (15.3 USD/MXN to 16.9 USD/MXN) and hit a record low of 17.2 USD/MXN on Aug 26, 2015. Source: Bloomberg and Reuters, 2015.
 Spurred by borrowing-cost differentials and depreciation expectations: for example, if the local interest rate is 12 percent per year and the USD interest rate is 2 percent, financial agents will borrow in USD as long as the domestic currency is expected to depreciate 10 percent or less. According to the Bank for International Settlements (BIS), since the global financial crisis the outstanding USD-denominated credit to non-bank borrowers outside the US rose from USD6 trillion to USD9 trillion. The main debtors – some are countries where the currency is under downward pressure – are: China (USD1 trillion), Brazil (more than USD300 billion), India (USD125 billion), Malaysia, South Africa, Turkey, and Latin America’s financially open economies: Colombia, Chile, Peru, and Mexico. EMs have witnessed a significant increase in their total external debts since the financial crisis. In Brazil, from USD 198.3bn (December 2008) to USD 348.5bn (December 2014); in Russia, from USD 545.4bn (December 2011) to USD 597.3bn (December 2014); in India, from USD 229.7bn (December 2008) to USD 461.9bn (December 2014); in China, from USD 390.2bn (December 2008) to USD 895.5bn (December 2014). During the same period, DMs have also witnessed a considerable increase in their external debt levels. In the US, from USD 4.0tn (December 2008) to USD 6.9tn (December 2014); in the EZ, from USD 13.1tn (December 2008) to USD 14.7tn (December 2014); in Japan, from USD 1.7tn (December 2008) to USD 2.7tn (December 2014). Source: Trading Economics, 2015.
 The aggregate BRIC CB balance sheet size as a share of BRIC GDP was 39.5 percent in June 2015, lower than 42.5 percent in December 2008. China has suffered a significant reduction in its balance sheet size as a percentage of GDP, while other BRIC countries have witnessed an increase: Brazil: 22.0 percent (December 2008) to 36.4 percent (June 2015), Russia: 0.95 percent (December 2008) to 1.04 percent (June 2015), India: 8.8 percent (December 2008) to 10.6 percent (June 2015), China: 74.3 percent (December 2008) to 52.8 percent (June 2015). Source: Trading Economics, IMF, 2015.
 In debtor economies, weak growth increased the ratio of net-external-liabilities to GDP, making some countries vulnerable to changes in market sentiment. Medium term risks are rising: over the next three years, debtor economies are unlikely to strengthen their growth performance and improve current account balances.
 The VIX – an index of stock market volatility that measures the implied volatility of S&P index options – reached a peak of 52.7 on March 2, 2009 and hit a bottom of 10.3 on July 3, 2014. In 2015, it rose from an average of almost 17 from 14 in 2014, and it has been above 20 for 27 days, twice as many days as the previous two years combined. Source: Bloomberg, 2015.
 US government bonds are more volatile than ever. In 2014, the yield on the 10-year Treasury fluctuated by ‘more-than-10 basis points’ only three times; in 2015, it has already occurred 17 times, and the yield’s average daily movement has increased by more than 50 per cent. Source: Bloomberg, 2015.
 The SLFSI – whose 18 components include yields on junk and corporate bonds, an index of bond market volatility, and the Standard & Poor’s 500 index – reached a peak of 3.568 on March 6, 2009 and hit a bottom of -1.601 on June 27, 2014, the lowest level on record since December 1993. It has been below zero for about three-and-a-half years (191 weeks). Source: Bloomberg, 2015.
 Recent short episodes of sharply-rising volatility: the “flash crash” of May 2010, when, in a matter of 30 minutes, major US stock indices fell by almost 10 percent, before recovering rapidly. Then came the “taper tantrum” in the spring of 2013, when US long-term interest rates shot up by 100 basis points after then-Fed Chairman Ben Bernanke hinted at an end to the Fed’s monthly purchases of long-term securities. On October 15, 2014, between 9:33 and 9:45 a.m., US Treasury yields dropped by almost 40 basis points (7 to 8 standard deviations). More recently, ten-year German bond yields rose significantly by almost 65 bps in a space of few days, from April 20, 2015 to May 13, 2015. Source: Reuters, 2015.
 In search of return, investors piled into riskier, less liquid instruments: fixed-income assets – such as government, corporate, and emerging-market bonds, longer dated securities, non-actively traded shares or less developed equity markets. After the 2008 crisis, over 13,000 new bond funds were created. Currently, bond funds have over USD7 trillion in investments, an increase of USD3 trillion since 2009. Much of the new funds have gone in less liquid securities such as corporate bonds. Source: Bloomberg, Economonitor, 2015.
 A few investors concentrate market activity. When the consensus-views change, very large players – holding similar portfolios and following similar investment strategies – try repositioning their portfolio at the same time, and trigger illiquidity events. US Treasuries are a case in point: the Fed is holding most of the supply; in times of stress, banks and hedge funds try to move large amounts away from riskier assets (stocks, junk bond ETFs, etc.) into the safe haven of US Treasuries, but often they do not find enough supply. Even exchange-traded funds (ETFs) – marketable securities that track an index, a commodity, bonds, or a basket of assets – struggle to function as liquid securities when subjected to market discontinuities.
 New regulations have significantly increased market makers’ cost of doing business. The Basel III capital accord has significantly increased the amount of capital required by banks and introduced liquidity requirements such as a ‘minimum liquidity coverage ratio’ and ‘net stable funding ratio’ which increases the cost of funding bonds. In the US, the 2010 Dodd-Frank Act and the Volcker rule increased capital requirements, restricted bank trading and banned banks’ proprietary trading. This resulted in a sharp contraction in the market making capacity of dealers, particularly in bonds (but also in other financial assets). In the US Treasury bond market, in 2007major dealers had around USD2.5-3 trillion capacity. Today that amount has fallen by over a third. Source: Brookings Institute, 2015.
 As large banks and other financial institutions are not anymore allowed to carry big trading positions, market liquidity is reduced. Financial intermediaries stabilize the markets by responding to temporary imbalances in supply and demand, and stepping in as buyers (or sellers) against trades sought by other market participants. Now,
 For example, “good news” (e.g. an higher-than-expected job creation) will inevitably lead to (further) monetary tightening, while “bad news” (e.g. a lower-than-expected job creation) will be seen as additional evidence of economic weakness. Early signs abound: on Friday September 18, 2015, a day after the Fed left interest rates unchanged on concerns about the global economy, investors sold stocks off and bought government bonds. Probably, the markets would have reacted the same way – on concerns about liquidity withdrawal – if the Fed has instead decided to hike and start a tightening cycle. Indeed, a week later, after Chair Janet Yellen argued the case for raising short-term interest rates later this year, the markets rallied at first, but almost immediately declined, concerned about the potential effects of a premature interest rate hike.
 More than a dozen banks in the DM that rose rates since 2008 due to various reasons, such as rising commodity prices (EZ) and housing boom (Sweden, Canada, Australia and Israel), had to lower them as their economies stumbled. In Norway, the Norges Bank began hiking rates by a percentage point in 2009 and then cut rates in late 2011 as Europe’s troubles weighed on the economy. In Israel, the Bank of Israel started to increase rates in 2009 and pushed them up by 2.75 percentage points by mid-2011, but then began to steadily lower them all the way down to 0.1 percent in March 2015, where they have stayed ever since. In Sweden, the Riksbank started lifting rates from 0.25 percent in Jul, 2010, but couldn’t get them above 2.0 percent before having to lower them just months later, as the Swedish economy headed for deflation. In Brazil, the ECB raised rates by 3.75 percentage points beginning in 2010 before having to cut them back below their starting point in 2011. Brazil began another round of rate hikes in 2013 (increased cumulatively by 7.0 percentage points to 14.25 percent) that it has yet to reverse. In the EZ, the ECB hiked rates by a 0.5 percentage point to 1.5 percent in 2011 only to begin to lower them again just four months later. The ECB eventually dropped rates to zero. In Australia, where there has not been a recession in 25 years, the Reserve Bank of Australia could only hold onto its 1.75 percentage increase in interest rates (during 2009-11) for a year before a rising unemployment rate caused it to cut rates in late 2011.
 The Fed has been over-optimistic about inflation before; it found itself repeatedly restarting its asset-purchase programs after inflation failed to rise to and stay near target when purchases were curtailed. The move toward Fed tightening has also destabilized global markets, squeezing emerging economies, putting downward pressure on commodity prices and pushing up the dollar.
 For example, in the US, if the Fed waits too long to raise rates then inflation could rise above 2 percent; at that point, people may lose confidence in the Fed’s ability to keep price increases under control. If it hikes too soon, however, then very low inflation might quickly become deflation, and the Fed will have little room to cut interest rates before returning to zero—and to untested, unconventional monetary policy.
 The Shanghai composite index fell by 25.5 percent over a period of 15 days, from 3927.9 (August 11, 2015, the date of the currency devaluation was announced) to 2927.3 (August 26, 2015). Source: Bloomberg, 2015.
 Since 2009, monetary injections in open economies translated into core-to-periphery capital flows, which – while reducing volatility and giving the appearance of stability – further intertwined currency markets. In August 2011, a downgrade of US credit rating from AAA to AA+ by S&P led to a slide in global equity markets. In October 2011, the write-down of Greek-government debt played a crucial role in triggering the Cyprus financial crisis of 2012-13, with two of the largest banks losing approximately EUR4.5bn (more than 25 percent of Cyprus GDP), resulting in significant damage to the Cyprus economy. In August 2015, China’s economic sputtering brought about a global market correction.
 BRIC countries holding of US sovereign debt has increased from USD 1tn (December 2008) to USD 1.7tn (December 2014) – Brazil: USD 127.0bn (December 2008) to USD 255.8bn (December 2014); Russia: USD 116.4bn (December 2008) to USD 86.0bn (December 2014); India: USD 29.2bn (December 2008) to USD 83.0bn (December 2014); China: USD 727.4bn (December 2008) to USD 1244.3bn (December 2014). China was the biggest foreign buyer of US Treasury debt for six years until early 2015. Source: Bloomberg, 2015.
 Table 6. Stocks have outperformed Bonds since the financial crisis.
Source: Bloomberg, 2015.
-I thank Francisco Quintana, Pablo Gallego Cuervo and Mert Yildiz for their comments and suggestions, PulsarKC for data collection. All errors are mine.
Note:Global Markets – Stock market performance: Dow Jones Global Index; Bonds performance: JPM Global Aggregate Bond Index. US – Stock market performance: DJIA; Bonds performance: Barclays Aggregate Bond Index. EZ – Stock markets performance: EuroStoxx 600; Bonds performance: Barclays Euro Aggregate Index.
S&P 500 – The index includes 500 leading companies in the US and covers approximately 80 percent of the available market capitalization; S&P 100 – A sub-set of the S&P 500, the Index comprises 100 major blue chip companies across multiple industry groups; Morgan Stanley Capital International Emerging Markets Global Index – A capitalization-weighted benchmark index covering equities from 29 developing countries; MSCI EM Equity – The index covers 23 countries and represents 13 percent of world market capitalization; JP Morgan Sovereign Bond Index – The index tracks DM and EM sovereign bonds; JP Morgan Corp. Bond Index – The index is widely used as the benchmark for EM corporate bonds; LPX50 Listed PE Companies – A global equity index, it covers the 50 largest listed private-equity companies; FTSE EPRA/NAREIT Global Real Estate Index – The index is designed to represent general trends in eligible real estate equities, worldwide; S&P GSCI Agriculture Index – A sub-index of the S&P GSCI, it provides investors with a benchmark for investment performance in the agricultural commodity markets; S&P GSCI Energy Index – A sub-index of the S&P GSCI, it provides investors with a benchmark for investment performance in the energy commodity market; S&P GSCI Precious Metals Index – A sub-index of the S&P GSCI, it provides investors with a benchmark for investment performance in the precious metals market; S&P GSCI Industrial Metals Index – A sub-index of the S&P GSCI, it provides investors with a benchmark for investment performance in the industrial metals market.