On Wednesday the volatility in financial markets had many recounting their memories of 2008. The CBOE Volatility Index (VIX), a key measure of market expectations of near-term volatility and termed the ‘fear index’, spiked to 30.88, up from 12.03 on September 18th, when the cracks first started to appear in the ECB’s plan to expand the balance sheet by circa €1 trillion.
As fear raged, most spectacular was the 35bps drop in the 10-year US treasury yield that occurred in minutes, hitting an intra-day low of 1.873% before stabilising and closing at 2.09%. However, the price action in bond markets and the sharp falls across equity markets was an eye opener for investors who have been complacent for some time now. The German DAX equity index fell to 8363 on Thursday, down almost 15% since the close on September 18th, while the German 10-year government bond yield hit a low of 0.72%. Those who reached for yield in Greece were really hurting as the 10-year government bond yield moved above 9%.
Eventually, the architects of this complacency on the other end of the panic button, the world’s major central banks, moved to reassure investors that they won’t have to go cold turkey if the withdrawal symptoms prove too much. Most notable were the comments on Thursday from St Louis Fed President James Bullard on delaying the end of the Fed’s bond purchase program (QE3), while on Friday the Bank of England’s Chief Economist soothed markets with the “lower for longer” tune. Who said divergence in monetary policy? Markets responded with glee, with many of the major equity indices recording their single best day this year.
I’ll just echo what I wrote recently on a possible delay of monetary policy normalisation. Some in the financial markets may view this as a positive, lower rates for longer, or even more QE, but in reality it would destroy any illusion of a self-sustaining economic recovery. QE to infinity……!