So that’s what volatility looks like

January 19, 2015 08:40 AM

It is hard to argue that the single biggest global macro factor influencing the markets these last years has been central bank monetary policy! 

In the United States for the past five years unprecedented Fed monetary policy has kept volatility levels down in the equity and fixed income markets with the objective of giving the economy and financial system a chance to heal from the damage caused by the subprime meltdown. With both the financial system and the economy seemingly on firm footing, 2015 was supposed to be the year the Fed begins to shift towards a more normal policy stance, leaving markets increasingly in charge of the price discovery process. But what the deflation concerns and the general level of uncertainty around the globe highlight is that unlike past exits from Fed easing programs no one really has any idea of what to expect this time around. Yes, there are plenty of theories and economic models but markets have proven time and time again that rationality does not always rule.

Now take into account the activities of central banks around the world, all essentially concerned with bringing about monetary stability as the mission statements of the U.S. Federal Reserve, ECB, BOE and BOJ show. While they may share this goal in common, it is important to realize that these institutions do not act in concert. Instead, their focus lies on their own economies, and the actions they choose to take may or may not be good for all.

We saw a perfect example of this in the week ending Jan. 16, 2015 when the Swiss National Bank (SNB) decided to abandon a policy, which had the Swiss Franc (CHF) pegged to the euro, reflecting Switzerland’s concerns over an increasingly aggressive ECB willing to intervene to tackle disinflation. This action caused the Swiss franc to spike some 30% against the euro in a matter of seconds. So while central banks around the world may wish to achieve and maintain price stability, the actions they take to achieve that end may result in some short-term volatility.

And the currency markets around the world are not the only markets showing signs of increasing levels of volatility, with interest rate and commodity markets developing in similar ways, giving rise to ample trading opportunities. While market outlooks may vary, we have certainly seen the futures markets move significantly just 16 days into the year as the below chart illustrates. 

 

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