Blog Post

The return of market volatility

What’s at stake: The size of the market gyrations this week took everybody by surprise. Several stories have been put forward to rationalize these movements, but the abruptness of the adjustment is puzzling and underlines that the degree of liquidity in these markets may have been overestimated.

By: Date: October 20, 2014 Topic: Global Economics & Governance

What’s at stake: The size of the market gyrations this week took everybody by surprise. Several stories have been put forward to rationalize these movements, but the abruptness of the adjustment is puzzling and underlines that the degree of liquidity in these markets may have been overestimated.

Last week wrap-up

We are definitely back in the “risk-on-risk-off” regime again

Sober Look writes that we are definitely back in the “risk-on-risk-off” regime again. In its Global Market overview, the FT notes this morning that high volatility will likely remain the story for now especially as expectation on monetary policies shift back and forth. Luigi Speranza write that market fluctuations have reached fever pitch over the past few days, with the continued decline in equity markets accompanied by new cyclical lows in bond yields and, more recently, a sharp widening of eurozone bond spreads.

Gavyn Davies writes that on Wednesday, the US ten year treasury, perhaps the most liquid financial instrument in the world, traded at yields of 2.21 per cent and 1.86 per cent within a matter of hours. This type of volatility in the ultimate “risk free” asset has previously been seen only in 2008 and other extreme meltdowns, so it clearly cannot be swept under the carpet.

What is the market telling?

The most prominent story since the September peak seems to be a “global slowdown” with associated “deflation

Gavyn Davies writes that overall three separate factors have probably been at work:

  • a reversal of speculative positions, which has had temporary effects on asset prices;
  • a contractionary and deflationary demand shock in the euro area;
  • an oil shock that will also be deflationary, but will be expansionary for many economies.

Robert Shiller writes that the most prominent story since the September peak seems to be one of a “global slowdown” with associated “deflation.” Underlying this tale are deeper, longer-term fears. There is a name for these concerns too. It is “secular stagnation” — the idea that there is disturbing evidence that the world economy may languish for a very long time, even for generations, as the word “secular” suggests. Gavyn Davies expresses doubts about this story since this fails to show up in any recent change in consensus GDP forecasts.

Paul Krugman writes that the financial turmoil of the past few days has widened the gap between what we’re told must be done to appease the market and what markets actually seem to be asking for. We have been told repeatedly that governments must cease and desist from their efforts to mitigate economic pain, lest their excessive compassion be punished by the financial gods, but the markets themselves have never seemed to agree that these human sacrifices are actually necessary. The real message from the market seems to be that we should be running bigger deficits and printing more money. And that message has gotten a lot stronger in the past few days.

Market volatility and growth

Roger Farmer writes that that a persistent 10% drop in the real value of the stock market is followed by a persistent 3% increase in the unemployment rate. The important word here is persistent. If the market drops 10% on Tuesday and recovers again a week later, (not an unusual movement in a volatile market), there will be no impact on the real economy. For a market panic to have real effects on Main Street it must be sustained for at least three months.  And there is no sign that that is happening: Yet.

A persistent 10% drop in the real value of the stock market is followed by a persistent 3% increase in the unemployment rate

Mohamed El-Erian writes that after a period of excessive risk taking and prolonged complacency, it will probably take some time for markets to fully recalibrate – a choppy process that will be driven both by fundamentals and by technically-oriented repositionings of crowded trades. 

Liquidity, regulation and price swings

Philip Gisdakis writes in Unicredit Sunday Wrap that with some clouds on the horizon, it took only a tiny trigger to send everyone bolting for the exit. With tightened market regulation also affecting banks’ trading books, market liquidity was gone within seconds, which resulted in huge price jumps. Mohamed El-Erian writes that traders are discovering – yet again – that market liquidity is not as deep as they had hoped for, causing wild price gyrations even in the most traditional of all asset classes (for eg, witness the speed and size of Wednesday’s price movements in US equities and Treasuries).

Gillian Tett writes that the question of “liquidity” – the degree to which assets can be traded – matters hugely. What is worrying is that liquidity appears to have decreased because unorthodox monetary policy experiments have collided with financial reforms and technological upheaval in an unexpectedly pernicious way. Having lots of money in the system does not guarantee that funding will flow freely, or that traders can cut deals. Systems flooded with cash can sometimes freeze.  Sometimes this occurs because investors lose faith in each other and stop doing trades, as they did in 2008. But markets can also become illiquid because it is difficult to match buyers and sellers. In the past big investment banks often matched buyers and sellers by holding large inventories of securities. But since 2008 banks have slashed their inventories by between 30 and 80 per cent (depending on the asset class) to meet tighter rules. This reduced their ability to act as market makers, and removed shock absorbers from the system.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

The US retail crisis

What’s at stake: America is undergoing a retail sector crisis, partly related to the increase of competition from online commerce. We review recent contributions to this debate.

By: Silvia Merler Topic: Innovation & Competition Policy Date: July 17, 2017
Read article More by this author

Blog Post

The Universal Basic Income discussion

What’s at stake: the concept of a Universal Basic Income (UBI), an unconditional transfer paid to each individual, was prominent earlier this year when Finland announced a pilot project. It’s now back in the discussion as the OECD published a report illustrating costs and distributional implications for selected countries. We review the most recent contributions on this topic.

By: Silvia Merler Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 12, 2017
Read article More on this topic More by this author

Blog Post

President Trump’s budget: the 3% growth quandary

What’s at stake: the Trump administration released its full budget proposal. Economists have been arguing about the feasibility of the underlying growth assumptions, and on whether there is a double-counting implied. We review the most recent contributions to this debate.

By: Silvia Merler Topic: Global Economics & Governance Date: May 29, 2017
Read article More on this topic More by this author

Blog Post

Dial N for NAIRU, or not?

What’s at stake: The concept of the NAIRU (Non-Accelerating Inflation Rate of Unemployment) has recently divided the minds in the economic blogosphere. We review the most important contributions on its usefulness, its shortcomings, alternatives and we discuss why it is such a contested concept.

By: Pia Hüttl Topic: Global Economics & Governance Date: May 22, 2017
Read article More on this topic

Blog Post

UK economic performance post-Brexit

What’s at stake: Almost a year after the UK voted to leave the European Union, its economic performance has showed mixed results. The risks of a Brexit-induced recession do not seem to be materialising. On the contrary, up until the end of 2016 the UK saw a continuation of strong consumer spending and strong output in consumer-focused activities. However, the UK economy is showing signs of slowing down in the first quarter of 2017, with weak growth in the services sector and business investments. In addition, strong consumption growth started to cool down as individuals’ purchasing power declines due to a weaker exchange rate. This leads to a question whether it is the beginning of the Brexit slowdown. We review the contributions made on this topic in the last year.

By: Uuriintuya Batsaikhan and Justine Feliu Topic: European Macroeconomics & Governance Date: May 15, 2017
Read article More on this topic More by this author

Blog Post

The US and the productivity puzzle

What’s at stake: Productivity growth fell sharply following the global financial crisis and has remained sluggish since, inducing many to talk of a “productivity puzzle”. In the US, we may be seeing what look like early signs of a reversal. We review recent contributions on this theme.

By: Silvia Merler Topic: Global Economics & Governance Date: May 8, 2017
Read article More on this topic More by this author

Blog Post

The Trump tax cut

What’s at stake: on Wednesday, the Trump administration - now 100 days old - unveiled a draft tax plan including the intention to enact a radical cut to the corporate income tax, lowering it to 15 percent. While we are still missing details on how this and other measures would be implemented, we review some of the early reactions.

By: Silvia Merler Topic: Global Economics & Governance Date: May 2, 2017
Read article More on this topic More by this author

Blog Post

The decline of the labour share of income

What’s at stake: at odds with the conventional wisdom of constant factor shares, the portion of national income accruing to labour has been trending downward in the last three decades. This phenomenon has been linked to globalisation as well as to the change in the technological landscape - particularly “robotisation”. We review the recent literature on this issue.

By: Silvia Merler Topic: Global Economics & Governance Date: April 24, 2017
Read article More on this topic More by this author

Blog Post

Embracing the silver economy

What’s at stake: The oldest human in known history was a Frenchwoman called Jeanne Calment who celebrated her 122nd birthday in 1997. Thanks to advances in technology and medicine humans living until 100, if not 122, might not be an exception in the near future. Ageing, while described as a looming demographic crisis, also offers a silver lining. Business in rapidly ageing societies is already adapting their strategies to navigate the “silver economy”. This blogs review looks at the implications of the silver economy on growth, productivity and innovation as well as the opportunities offered by the silver industry.

By: Uuriintuya Batsaikhan Topic: Global Economics & Governance Date: April 10, 2017
Read article More by this author

Blog Post

Is China’s innovation strategy a threat?

What’s at stake: A number of recent contributions accuse China of acquiring technology from abroad without respecting international rules. This blog reviews the current debate that focuses on China’s supposed push to modernise its industry and the challenges for advanced economies. By leapfrogging to high-tech manufacturing products, the strategy threatens the competitive advantage of the US and the EU. The international rules-based order is put to a test facing large-scale government support to high-value added sectors and anti-competitive behaviour.

By: Robert Kalcik Topic: Global Economics & Governance, Innovation & Competition Policy Date: April 3, 2017
Read article More on this topic More by this author

Blog Post

The American opioid epidemics

What’s at stake: The US Department of Health and Human Services (HHS) declares that the country is “in the midst of an unprecedented opioid epidemic”. Since 1999, the rate of overdose deaths involving opioids - including prescription pain relievers and heroin - nearly quadrupled. We review contributions looking at the economic drivers and implications of this phenomenon.

By: Silvia Merler Topic: Global Economics & Governance Date: March 27, 2017
Read article More on this topic More by this author

Blog Post

Alice in gender-gap land

What’s at stake: The International Women’s Day on 8 March drew attention to the gender gap again, both in pay and in employment. Ongoing research on the topic shows that the gender gap persists worldwide, from finance to arts. For it to change, bold action is needed, ranging from targeted policies to rethinking gender norms.

By: Pia Hüttl Topic: Global Economics & Governance Date: March 20, 2017
Load more posts