- Financial markets appear to have returned to normal after a spike in volatility earlier this month.
- ANZ Bank points to three individual indicators that suggest a return to the low volatility environment in recent years is unlikely.
- It says volatility will remain “higher on average”.
After a rocky start to the year, financial markets have got their mojo back, behaving in much the same manner seen before the sudden bout of volatility.
Stocks are ripping higher, bond yields are lower and the VIX index — having spiked to above 50 in early February — is now back below 16.
Expected volatility, or to some, fear, has subsided substantially.
Suddenly, the financial world is suddenly good again.
Or is it?
To Daniel Been and Giulia Lavinia Specchia, FX Strategists at ANZ Bank, while things on the surface look like they’re returning to what was normal over the past couple years, there are enough indicators out there to suggest otherwise.
To them, the “market plumbing is sending a more cautious message”.
To demonstrate that point, they have three charts that suggest it’s still far too early to say that financial market volatility is over.
“Funding spreads are widening out as supply becomes a more significant issue and this is adding a new element to the liquidity tightening we were already observing,” they say, pointing to the chart below showing the spread between overnight and three-month US interest rates is continuing to increase, indicating that perceived credit risk is rising.
Been and Specchia also point to a higher volatility in economic data in the world’s largest economies as a sign that financial market volatility may also remain elevated.
Surprises are increasing, in other words.
“The volatility of economic data is continuing to rise — now in the 60th percentile — and this too is a typical precursor to a more volatile market environment,” they say.
As noted by Bloomberg late last year, divergences between economic and financial market volatility tend to only last for brief periods.
Finally, Been and Specchia that cross asset correlations are also starting to increase, hinting that the “risk on, risk off” moves across markets seen in the years following the global financial crisis may also be about to return.
“When assets start to more together it’s a reliable signal that markets are becoming more vulnerable to shock, and as such, more volatile,” they say.
Given these indicators that have acted as lead indicators for increased financial market volatility in the past, Been and Specchia suggest there’s still plenty of reason for caution.
“When looking across a number of our indicators, there is a uniformity in their message — we are in a new regime and volatility will remain higher on average,” they say.
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