Crash Catalyst – Freeze to Flight
Yesterday we spoke of the “elephant in the room” with regard to the effect of central banks moving to tighten on global financial markets and there was plenty of news around this overnight. Last night the Fed released the minutes of their last meeting and they have been described as ‘schizophrenic’ in that on one hand they spoke of “many Fed officials concerned low inflation is not transitory," but then "many Fed officials saw another rate hike warranted this year". So our repeated warnings of a rate hike into weakness seem to be reiterated by the very instigator… Gold understandably jumped on the news… but shares kept going as well.. why?
Former fund manager and Bloomberg commentator Richard Breslow bravely made the call last night:
"as the long running debate about lack of volatility in the markets continues, I’ve got some good news for you. As long as you promise to be happy with what you wish for. It’s about to change…..I’m talking about good old fashioned two-way flow and nascent trends galore. And I’m officially declaring today the very start of the entire change over process.”
Volatility, or more specifically the lack of it, is most certainly one of the main themes in markets today. Simplistically that ever present central bank hand of support would explain it, so what happens when that is removed. Deutsche Bank just released a report that asks the question, is it complacency or are investors in ‘freeze’ mode amidst all the global uncertainty at the moment. They reference a similar thesis by the winner of this year's Nobel prize in economics, Richard Thaler of the University of Chicago. So what could move this from freeze mode to flight mode?
"the most likely causes of a shift to ‘flight mode’ and a rise in volatility? Here’s one possibility: by the end of next year, the combined expansion of all the major Central Bank balance sheets will have collapsed from a 12 month growth rate of $2 trillion per annum to zero."
Enter Exhibit “Elephant” we referred to yesterday…
The IMF have joined the chorus, warning that the market is now particularly sensitive to spikes in volatility:
Deutsche concludes somewhat ominously:
"As we look at what could shake the panoply of low vol forces, it is the thaw in Central Bank policy as they retreat from emergency measures that is potentially most intriguing/worrying. We are likely to be nearing a low point for major market bond and equity vol, and if the catalyst is policy it will likely come from positive volatility QE ‘flow effect’ being more powerful than the vol depressant ‘stock effect’. To twist a phrase from another well know Chicago economist: Vol may not always and everywhere be a monetary phenomena – but this is the first place to look for economic catalysts over the coming year."
Whilst they talk of this ‘catalyst’ coming next year, markets have taught us time and again that the only accurate predictor of a bubble bursting is hindsight. There is a famous saying in gold circles… better a year too early than a day too late.