##has been coming to an end since the spring of 2006 both in the us and in the euro area. until early may, the increase in long - term interest rates in the major economic areas ( shown in the chart on the left on slide 5 ) has had relatively little impact on global asset prices or on asset allocation. but, there have been some signs that the “ search for yield ” which began in 2003 could be ending. the recent increase in financial market volatility, after the review was finalised, and the flight - to - safety into government bonds suggests that a process of re - pricing of risk could be starting in financial markets. the key question from a financial stability perspective is whether this process will proceed in an orderly manner. a major destination of funds searching for yield, namely emerging market bonds, were particularly exposed to increased volatility over the recent weeks ( as shown in the chart on the right on slide 5 ). while spreads widened, they still remained very narrow. while the longer - term narrowing of spreads on emerging market bonds over the past couple of years has to a considerable extent reflected the improved fundamentals, including substantially reduced indebtedness in emerging market economies, it cannot be excluded that some mis - pricing of risk will be exposed when capital inflows are reversed. the turbulence in march in the icelandic financial markets, although contained, reminds us that vulnerabilities exist in parts of the world financial system. 4. euro area macro - financial environment let me now turn to the euro area macro - financial environment, focusing on developments in the corporate and household sectors that are of particular relevance for the outlook for financial intermediaries ’ credit portfolios. the balance sheet of the euro area non - financial corporate sector has strengthened significantly over recent years following notable improvements in profitability as well as debt restructuring efforts. looking forward, however, a number of risks could be looming. the chart on the left on slide 6 shows that after several years of decline, corporate sector borrowing in the euro area has picked up considerably over the past year. the fact that non - financial corporations have started to re - leverage their balance sheets can be interpreted as a positive indicator for investment activity. at the same time, increased leverage is augmenting a significantly higher level of indebtedness than witnessed in past recoveries. it cannot be excluded that corporate sector credit quality could deteriorate somewhat in the future, especially if the macroeconomic environment turns out less benign than currently fore

3 other euro area financial institutions – insurance companies and hedge funds allow me now to turn to non - bank financial institutions, focusing on insurance companies and hedge funds, two sectors that have been at the centre of attention during the past year. despite significant losses incurred by the reinsurance sector following the damage caused by natural catastrophes, the financial performance of the euro area insurance sector as a whole improved in 2005, owing to stronger investment income, improving underwriting income and rising equity prices. market - based indicators suggest that the outlook for the sector remains favourable in the immediate future. however, there are a number of risks facing the industry in the period ahead. these include the possibility of premium competition in the non - life sector, longevity risk in the life sector, and the possibility, albeit diminishing, of an influenza pandemic. the chart on the left on slide 12 portrays the performance of the insurance sub - sectors relative to the dow jones euro stoxx. whilst the impact on the reinsurance sub - sector of the damage caused by natural catastrophes is evident, other sub - sectors appear more resilient. the chart on the right on slide 12 shows the median expected default frequency and average subordinated debt spread for euro area insurance companies. both measures of risk in the sector have reached new lows since 2001, indicating that market participants see an improving resilience in the sector. the current review contains for the first time a specific section dedicated to assessing developments in the global hedge funds sector. the pace of growth of the capital under management of global hedge funds, which had moderated in the course of 2005, fluctuated rather sharply in the first months of 2006, partly due to the mixed performance of most strategies in the last quarter of 2005 and improved results in the first quarter of 2006. after several quarters of reduced inflows into the hedge fund sector, and an outflow in the last quarter of 2005, inflows re - bounded in the first quarter of 2006 as shown by the chart on the left on slide 13. looking forward, however, the possibility of tighter global liquidity conditions has raised investor redemption risk for hedge fund managers, particularly as the share of less liquid assets has reportedly been increasing. at the same time, correlations of returns within some hedge fund investment strategies and among strategies remained high or even increased, raising the risk of disorderly synchronous exists from similar trades in an environment of unexpected market turbulence. this is illustrated in the chart on