lunes, 2 de junio de 2014

lunes, junio 02, 2014

May 29, 2014 5:16 pm

Tranquil markets are enjoying too much of a good thing

After years of monetary experiments, central banks will do ‘whatever it takes’


Something peculiar is happening in western capital markets. This month almost every measure of volatility has tumbled to unusually low levels. If you look at the degree of actual (or “realised”) price swings – and projected (or “implied”) future movements investors are behaving as if the world is utterly boring.

This is bizarre. Financial history suggests that at this point in an economic cycle, volatility normally jumps; when interest rate and growth expectations rise, asset prices typically swing (not least because traders start betting on the next cyclical downturn). And aside from economics, there are plenty of geopolitical issues right now that should make investors jumpy. European elections have just propelled populist leaders into power, and events in Ukraine and the Middle East are tense.

But investors are acting as if they were living in a calm and predictable universe. Take a look, for example, at Wall Street’s so-called fear index”, the Vix, which measures the implied volatility of S&P 500 equities. During the financial crisis this surged above 80, and later sank to half that; it is now just above 11, a low level not sustained since 2007.

Similarly, the “implied equity vol-of-volindex (a derivative of volatility measures) is at its lowest level since 2006, and implied volatility in the euro-dollar currency markets is at its lowest since 2007. Bond price swings are very low too, and realised and implied price volatility for oil prices is also at a decade low.

“There is no demand for protection [against turbulence],” observes Mandy Xu, an equity derivatives strategist at Credit Suisse. “[Investors in] the options markets are not pricing in any big macro risks. This is very unusual.”


Why? If you want to be optimistic, one possible explanation is that the economic outlook has turned benign. For while western economic growth rates have been disappointingly slow since 2008, the good news is that recovery is now afoot, at a surprisingly steady pace. The disaster scenarios that used to spook investorssuch as an imminent break-up of the eurozone or technical bond default in Washington have not materialised; or not yet. More important still, after several years of wild monetary experiments, investors are more willing to accept that western central bankers will do whatever it takes to support the markets; they thus expect rates to remain stable and low for a long timeeven if some central banks, such as the Federal Reserve, reduce their level of stimulus.

But there is a second, less benign possible reason for low volatility: markets have been so distorted by heavy government interference since 2008 that investors are frozen. One issue that may account for the pattern, for example, is that tougher regulations have prompted banks to stop trading some assets. Another is that ultra-low interest rates have made investors reluctant to deploy their cash in public, liquid markets.

And there could be a more subtle issue at work too: investors are so unsure what to make of this level of government interference that they are unwilling to take any big bets. Far from being a sign of sunny confidence in the future, ultra-low volatility may show that investors have lost faith that markets work.


In reality, nobody knows which of these explanations holds true; I suspect that government meddling and low interest rates are the key factors here, but academic research on this issue is thin. However, one thing that is clear is that the longer this pattern remains in place, the more wary investors and policy makers should be.

For while ultra-low volatility might sound like good news in some respects (say, if you are a company trying to plan for the future), there is a stumbling block: as the economist Hyman Minksy observed, when conditions are calm, investors become complacent, assume too much leverage and create asset-price bubbles that eventually burst. Market tranquillity tends to sow the seeds of its own demise and the longer the period of calm, the worse the eventual whiplash.

That pattern played out back in 2007. There are good reasons to suspect it will recur, if this pattern continues, particularly given the scale of bubbles now emerging in some asset classes. Unless you believe that western central banks will be able to bend the markets to their will indefinitely. And that would be a dangerous bet indeed.


Copyright The Financial Times Limited 2014.

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