The latest version of the Bank for International Settlements’ Quarterly Review was released today, revealing that trading in exchange-traded derivatives markets continues to grow.

In the second quarter, the combined turnover of interest rate, equity index and currency contracts increased by 13% from the first quarter, it noted. “The turnover of contracts on short-term yen interest rates soared several months ahead of the rate hike by the Bank of Japan. There was also heavy trading of equity index contracts in May and June, during the retreat from risky assets,” it reported.

In the international debt securities market, issuance remained very strong in the second quarter of 2006, the BIS said. “It was bolstered by securitisation activity as well as by corporate borrowing, with a number of firms tapping the international market to fund mergers and acquisitions. However, issuance by emerging market borrowers slowed sharply, owing mainly to the absence of sovereign issuers. The favourable financial position of many sovereigns allowed them to pay down their international debt in the second quarter,” it explained.

In the international banking market, activity continued to expand at a very rapid pace in the first quarter of 2006, it said. “Banks in the BIS reporting area either maintained or increased their exposures to almost all countries, including many emerging markets and a number of countries where financial markets were unusually volatile. Interbank and inter-office flows accounted for much of the increase in cross-border claims, although they seemed in turn to be driven by a pickup in corporate borrowing. Despite a large increase in claims on emerging markets, these markets again saw net outflows as a result of an even larger increase in deposits placed with reporting banks,” it added.

The report also indicates that markets focused on monetary policy in the second quarter. “The upward trend in government bond yields that had been evident in major bond markets for much of the year ended in June. This was largely due to investor perceptions of weakening economic growth, in particular in the United States, and markets reassessing the likelihood of further rate hikes by the Federal Reserve,” it said. “Monetary policy decisions by other major central banks and expectations about their future actions also shaped developments in global bond markets.”

“In world equity markets, prices gradually recovered after the broad sell-off in May and early June, but volatility remained higher than before the turbulence,” the BIS said. “Implied volatilities also stayed above earlier levels, suggesting heightened uncertainty among investors about the near-term direction of equity prices. This may partly have been fuelled by concerns about the economic slowdown in the United States and questions about the outlook for corporate profits amidst higher oil prices and geopolitical tensions. However, equity prices were supported by falling bond yields and a generally favourable outlook for growth in the euro area and Japan, as well as positive second quarter earnings announcements.”

The second part of the report presents five special feature articles addressing the following topics: the changing composition of official reserves; the domestic implications of foreign exchange reserve accumulation in emerging markets; forward currency markets in Asia and lessons from the Australian experience; derivatives activity and monetary policy; and, an examination of the past 150 years of financial market volatility.