Post financial crisis we have seldom seen volatility of the extent that we have experienced recently. Certainly, at least not on such a widespread level that has regularly been characterised by simultaneous write-downs in normally negatively correlated assets. Financial headlines last week at least attested to some concrete actions to justify such violent moves in markets.
Trading last week still punished high risk assets as a continued risk-off tone in markets undermined demand and risk appetite in numerous sectors. However, what emerged at least from the perspective of volatility and disturbance in markets was one of the best case and smoothest scenarios possible.
In recent trading sessions, central banks controlling the three major western economies: the Federal Reserve, the European Central Bank and the Bank of England have all changed the backdrop of their economies considerably. The relative calm in markets from a price perspective was largely due to the strong signposting from the central banks to markets allowing participants to position accurately for the announcements.
The Federal Reserve opted for a vanilla interest rate hike but of a magnitude not seen for many decades with a 75 basis-point hike. The ECB provided nothing in its initial announcement but in an emergency meeting tasked the Council to create a brand new mechanism to ease financing conditions in the bloc. The Bank of England also pursued a fifth consecutive interest rate hike.
Despite immense central bank intervention, there may still be a problem: whilst markets listened to the central banks and positioned accordingly, the public is either not listening or not believing what they’re saying. We can see that because the public’s inflation expectations are outstripping the banks’ and professionals’ forecasts. During the era of ultra-accommodative policy, consumer apathy to central banks didn’t matter, now the story is very different. Inflation expectations can be a central bank’s best friend or worst nightmare and the way the public responds to hopefully moderating prices will be key to how each authority can manage the risks within its economy.
Discussion and Analysis by Charles Porter