Volatility across asset markets … has fallen to record lows. Low volatility – in itself not an unusual phenomenon in the middle of business cycles – reflects the low level of perceived risks among investors.
That is the opening paragraph from an analysis published by a leading investment and asset management firm — in July 2014. The analyst went on to note that “The implied volatility in equity, bonds and currency markets has declined across the board, with the average now falling below its previous low in February 2007.”
That note and hundreds of similar analyses published in the summer months sought to ascertain the significance, if any, of the phenomenon of extremely low volatility. The general conclusion was that although low volatility could be seen as a positive indicator that reflected a benign economic and financial backdrop, the historical record was clear-cut: periods of very low volatility were almost always followed by spikes in volatility. Not always spelled out in these analyses was the unpleasant fact that the spikes were generally accompanied by — indeed, were an intrinsic aspect of — sharply falling markets.
In the half-year or so since that was published, volatility has returned to the financial markets with a vengeance. Commodity markets have crashed, most currencies have slumped against the dollar and many emerging equity markets have been hammered. Bond yields and (inversely) prices have also become far more volatile and even the equity markets in developed countries, including the US, have seen a dramatic change in tone.
Whereas, in the period ending in September, US equity markets had seen a period of exceptionally low volatility, that changed dramatically in October and the new pattern continued through year-end and intensified in 2015. Moves of more than one percent up or down on a daily basis have become the norm, with intraday swings reaching as much as three or four percent from high to low and sometimes back again.
But the increased volatility in the equity markets has been mild compared to that seen in the currency markets. The Swiss franc has, however improbably, become a star performer in that respect — but is by no means alone. Yet even the currency gyrations pale in comparison with what has been happening in the oil market, especially this week.
Oil and other energy markets have, as noted, been plunging for months. But, beginning last week, they finally turned round. At first this seemed like a typical ‘correction’ — usually defined as a move of 5-10%.
But within the space of a few trading days, oil prices soared by more than 20% which, according to standard market definitions, constitutes a self-contained ‘bull market’ — a move that should take weeks or months to consummate. In fact, from the low point in Monday’s trading to the high-point on Tuesday, oil shot up over 16% in New York.
Nothing daunted, prices then crashed by almost 10% in a single day’s trading. But yesterday (Thursday) they were up again by 5-6%. Attempts to ‘explain’ these wild swings by relating to ‘fundamentals’, such as the build-up of crude oil supplies, or by pointing to geo-political factors, all ring false when the seemingly logical analysis of what caused yesterday’s price move is rendered ludicrous by an offsetting move today and then another slump or jump tomorrow.
It is tempting to ignore this wild and wooly market lunacy as having no meaning except to traders — who, being in a dangerous line of business, should know how to look after themselves or be ready to pay the price. However, that attitude — whether motivated by flippancy or misplaced morality — is unjustifiable.
Traders’ business is to make markets function smoothly. If markets go berserk and destroy the traders, that doesn’t make anyone better off. But more importantly, the increased volatility is a clear symptom of ‘illness’, i.e. market dysfunction, and if it forces more traders and investors out of the market, or discourages them from entering it, then the symptoms will get worse — but their cause, whatever it may be, will certainly not get better.
Oil is a very important market, not just to Saudi princes and Russian oligarchs, but to everyone. The bond market, especially government bond markets, are even more important, because they are the lynchpin of the entire financial system.
That being so, the fact that the yield on 10-year JGBs (Japanese government bonds) rose steadily for several months, from the already absurdly-low level of 0.6% per annum to the insane level of 0.2% and then, in a matter of days, plunged back to 0.38%, is a matter of grave concern. At least it should be, but the mainstream financial media have paid almost no attention, preferring to breathlessly report on and ‘analyze’ the oil gyrations noted above.
In short, the markets are screaming that they are going off the rails. The evidence is mounting that the central banks’ attempt to dictate the behavior of the global financial system has reached its inevitable and disastrous end.