The RBA has delivered the clearest warning of almost any central bank this year about the dangers of complacency that results from low market volatility.
In “Box C” of its quarterly Statement on Monetary Policy the RBA looked at low volatility in financial markets and highlighted a “notable feature of global financial markets in 2014 has been the very low level of price volatility”.
It is a situation which the RBA is warning traders and investors to be wary of in no uncertain terms:
History suggests that the current low volatility environment will not persist indefinitely. When a shock eventually occurs that is sufficiently large to cause volatility to increase, investors that had responded to the earlier decline in volatility by increasing leverage or their exposure to riskier assets could face significant losses. The resulting unwinding of these positions in an environment where there are large numbers of investors seeking to exit the same positions increases the likelihood that some markets could become one-sided, thereby exacerbating the initial rise in volatility
This is exactly how volatility transitions from low to high – complacency to fear.
Worryingly, as Graeme Jarvis from Westpac has recently been pointing out, and as the Ukrainian situation, the recent sell off in stocks, the rally in core bond markets like the US, Germany and the UK (while peripheral markets selloff), the fall in crude, today’s announcement that the US is again engaging militarily in Iraq and crucially the break in our timezone of a huge level in S&P 500 futures suggest, this period of low volatility might already be coming to an end.
Investors and traders would do well to heed the RBA’s warning.
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