M acroeconomic environment Financial Stability Report 2019
While the overall economic outlook suggests a continuation of the low interest rate environment, an eventual repricing of global risk premia could have serious consequences. Incentivized by the long low-interest rate environment, indebtedness has increased in many countries, with public and private sector debt levels often above the thresholds associated with debt overhangs. In this context, public debt sustainability concerns may resurface. While high debt levels of households and non-financial corporations ( NFC ) make them vulnerable to an abrupt increase in interest rates, a market repricing could also affect funding conditions of banks, in particular institutions that are dependent on market-based unsecured funding. Lower yields on safe assets pose severe structural challenges for institutional investors in Swiss and euro area bond markets. In the current environment, insurers and pension funds may have to raise the credit risk of their portfolios to maintain a certain level of profitability ( or even to reach positive returns ). This structural issue will be particularly challenging in future years, as the decrease in interest rates in 2019 may lead to short-term one-off capital gains arising from higher valuations in the present year. At the same time, the strong effects of lower
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yields on the liabilities side of insurers across Europe – associated with strongly negative effects on solvency indicators – is less pronounced for the insurance sector in Liechtenstein, as the lion’s share of capital investments is attributable to investments managed for the account and risk of policy holders as part of unit-linked ( f und-linked ) life insurance. Looking ahead, risks of abrupt corrections in financial markets remain elevated. In the face of high political and policy uncertainty and the strong cyclical downturn, the risks of strong financial market corrections are substantial. In addition, highly leveraged firms that have benefited from the low interest environment in recent years face a higher risk of downgrades and widening risk premia in a recessionary environment with declining earnings. The risk of a correction in safe asset prices is less pronounced, at least in the short term, in light of the weak economic outlook and the high degree of monetary policy accommodation. Nevertheless, a benign scenario associated with a strengthening macro outlook and fading expectations of further monetary policy easing could lead to a reassessment of low yields on higher-rated bonds, which would have negative short-term effects on bond valuations.