Financial markets are quiet nowadays. Some may even say they’re boring.
Be it the threat of nuclear war or the prospect of monetary policy normalisation, among other risks, markets, seemingly, are unperturbed.
Yes, a few pockets of volatility remain, particularly in commodity markets, but elsewhere day-to-day movements are tame, especially in stocks.
If the S&P 500 Volatility Index, or VIX, is truly seen as an “investor fear gauge” as some have dubbed it, investors around the world are clearly relaxed about what lies ahead.
As pointed out above, there’s no shortage of risks, and many assets have been boosted to elevated levels after years of central bank policy easing.
And there’s no shortage of hypotheses put forward to explain why financial market volatility has all but evaporated.
Many are centred around central bank policy, with years of quantitative easing encouraging investors to buy into any weakness, no matter how small, on the view that central banks will be there to support markets though asset purchases.
Others suggest that the passive investment strategies, seen in the enormous increase in the use of exchange-traded funds (ETFs), has also been a major factor that has dulled volatility levels.
While HSBC’s global multi-asset strategy team believes that they have been a major factor that has numbed markets to perceived risks, it says that this alone doesn’t explain why volatility currently sits near the lowest levels on record.
In order to determine what other factors have dulled market movements, HSBC created a new ‘Cross Asset Volatility Indicator’, an aggregate measure of realised volatility across geographies and asset classes, including rates, FX, equities, credit, and commodities.
Here’s where cross-asset volatility currently ranks compared to prior periods.
It’s very low, largely reflecting a dramatic decline in volatility in stocks compared to historic norms, as seen in the chart below.
So volatility is low, and it’s been driven by stocks.
HSBC says that while central bank policy and passive investment has contributed to this slide, there are other factors involved.
“Both have no doubt played a role in suppressing volatility. However, that can’t be the full story,” it says.
“Given the fact that both causes have been in place for many years, while they may serve as reasonable explanations of the long-term drift low in volatility, they fail to explain why it has fallen to such extreme lows over the past seven months.”
In the bank’s opinion, the reason volatility has fallen so far this year can be explained by something that has not been seen in the post financial crisis era: we’re currently in a synchronised global economic upswing.
“Growth is also not simply moving higher, it is also beating forecasters’ expectations. Q2 saw a string of positive growth surprises, with GDP coming in better than expected in countries including Japan, Canada, China, Brazil, South Africa and Russia,” HSBC says.
“At the same time as growth has picked up, the dispersion of GDP growth rates has also declined. So while much of the developed world — including the US, Eurozone and Japan — is growing at above-trend growth rates, much of the emerging world, while also accelerating, is growing at a rate that is probably still below potential.”
So growth is not only beating market expectations, it’s also becoming more predictable.
“Taken together, this should mean reduced uncertainty about global growth, which in turn should help to suppress market volatility,” HSBC says.
Along with global economic conditions, the bank says that continued low levels of inflation are also acting to keep volatility in check, ensuring that global central bank policy remains accommodative and largely predictable.
Coupled with a pullback in expectations for longer-dated global bond yields and solid corporate earnings, HSBC says these factors, along with central bank policy and the rise of passive investing, help explain why market volatility remains so low.
“This combination of steady growth, benign inflation, and stable long-end yields implies a world of reduced uncertainty in future cash flows and discount rates which, all else being equal, should result in lower equity volatility,” it says.
“At the same time, lower growth dispersion and smaller economic surprises should also serve to reduce uncertainty more broadly, helping to contain volatility in other asset classes.”
In a nutshell, less uncertainty is leading to less volatility.
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