MOTB: expect ‘continued volatility’ in financial markets

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Volatility in financial markets is likely to continue for some time to come, according to one of the speakers at the latest Room151 conference. Monthly Treasury briefing online (MOTB).

Cameron Shaw, senior portfolio manager at Ardea Investment Management, said the “one-in-a-hundred-year event” in the gilt market following the UK mini-budget is unlikely to happen again. However, general volatility is said to be an ongoing issue in financial markets.

“Governments used to be volatility suppressors, but now they are creators. You will see a lot more volatility in bonds in traditional safe havens and in equities in general going forward,” he said.

In a presentation at the briefing entitled “Stretched to breaking point”, Shaw compared the performance of different asset classes during the first half of 2022. He pointed out that almost all major asset classes had suffered significant losses during of this period.

It recorded the worst first-half calendar year performance for the S&P500 since 1962, for U.S. high-yield credit since 1989, the Japanese yen since 1989 and U.S. 10-year Treasuries since the 1970s.

You will see a lot more volatility in bonds in traditional safe havens and in equities in general going forward.

Nowhere to hide

“This year has been a very volatile period in the financial markets. Outside of commodities and the US dollar, there was nowhere to hide,” Shaw said.

“There have been huge losses in equities, credit markets, emerging markets, every asset class you can think of. And even worse losses since the start of the year than during the crisis financial year of 2008.

Shaw suggested the situation was caused by unexpected high levels of inflation across the world, forcing central banks to raise interest rates. This aggressive tightening meant that traditional safe havens, such as government bonds, suffered “equity-like” declines.

“Why did this happen? It’s because central banks had their heads in the sand this time last year. They assumed inflation was transitory, which it clearly wasn’t,” did he declare.

Central banks were “massively behind the curve and had to play catch-up,” Shaw told briefing participants.

Central banks had their heads in the sand this time last year. They assumed that inflation was transitory, which was clearly not the case.

Unfunded fiscal stimulus

In the UK, “gasoline was thrown on the fire” by the September 23 mini-budget, which promised a major unfunded fiscal stimulus at a time when inflation was already a problem.

This caused bonds to sell off and yields to rise 200 basis points in the space of a few days. As a result, the Bank of England was forced to announce that it would temporarily buy bonds in an effort to calm the market.

Yields on UK gilts are now back to levels seen before the mini-budget. But Shaw suggested that inflation had not yet peaked and that central banks were likely to be “tightening too much”.

“Central banks are going to err on the side of tightening. So unlike this time last year when they were behind the curve, they are actually ahead of the curve.

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