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Chicago Fed Letter

A New Framework for Assessing Climate Change Risk in Financial Markets

Nahiomy Alvarez, Alessandro Cocco, and Ketan B. Patel

While there is growing recognition that climate change poses a new risk for the economy, more research is needed to understand how climate change risk affects global financial markets. We establish a new framework for this research by merging the climate change risk categories of physical risk, transition risk, and liability risk with the risk categories commonly assessed in the financial markets: market risk, credit risk, liquidity risk, and operational risk. We then factor in market structure and market regulation as we seek to assess the overall impact of these variables on systemic risk. Our framework shows that climate change affects each of the risk-management categories commonly assessed in the financial markets as well as the ways that they interact to generate broader systemic risk.

Looking Down the Road with ALEX: Forecasting U.S. GDP

Scott A. Brave, R. Andrew Butters, and Michael Fogarty

In this article, we examine the recovery from the recession that began with the onset of the Covid-19 pandemic in the U.S. To do so, we present and discuss for the first time the results from a mixed-frequency Bayesian vector autoregressive model called ALEX. This model uses 107 monthly and quarterly indicators of economic activity to forecast the near-term path of U.S. real gross domestic product (GDP).

How Central Bank Swap Lines Affect the Leveraged Loan Market

Annie McCrone, Ralf Meisenzahl, Friederike Niepmann, and Tim Schmidt-Eisenlohr

The cost of borrowing U.S. dollars through foreign exchange (FX) swap markets increased significantly at the beginning of the Covid-19 pandemic in February 2020, indicated by larger deviations from covered interest rate parity (CIP).1 CIP deviations narrowed again when the Federal Reserve expanded its swap lines to support U.S. dollar liquidity globally—by enhancing and extending its swap facility with foreign central banks and introducing the new temporary Foreign and International Monetary Authorities (FIMA) repurchase agreement facility for foreign and international monetary authorities.2 Recent research by Meisenzahl, Niepmann, and Schmidt-Eisenlohr (2020) shows how wider CIP deviations result in higher borrowing costs for U.S. corporations in the leveraged loan market. In this article, we discuss this finding, which suggests that, besides other channels, the Federal Reserve’s initiatives to provide global U.S. dollar liquidity contributed to easier financial conditions for U.S. corporate borrowers.

Measuring the Relationship Between Business Reopenings, Covid-19, and Consumer Behavior

By Diane Alexander, Ezra Karger, and Amanda McFarland

On March 17, 2020, seven counties in the San Francisco Bay Area put into place the first stay-at-home orders in the United States. In the following weeks, counties and states implemented a cascading sequence of stay-at-home orders, bans on public gatherings, shutdowns of nonessential businesses, and face mask mandates. But as small businesses began to face financial insolvency, states and counties began easing these restrictions. To evaluate the effectiveness of policies restricting mobility and business activity, it is important to document the effects of reopening businesses on public health and economic activity. In this Chicago Fed Letter, we measure the relationship between state-level reopenings of nonessential businesses and health outcomes (Covid-19 cases and deaths), mobility, and revenue at small and large retail businesses.

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