LONDON, Sept 29 (Reuters) - This week’s sharp commodity-driven selloff will set alarm bells ringing once again for global regulators who are growing increasingly nervous that, after 12 months of market shocks, the next one might be too big for them to handle.
With three months to go, 2015 is already the most volatile calendar year for markets since the depths of the global crisis in 2008, according to analysis from State Street Global Advisors.
Last week the Bank of England and European Union both issued financial stability reports echoing concerns from the Bank for International Settlements that historically low interest rates are fuelling market volatility and distortions.
That warning came home to roost as soon as Monday, when data showing a sharp fall in Chinese industrial firms’ profits sparked a slump in global equity markets and commodities, with mining blue chip Glencore shedding 30 percent.
Central banks are in something of a bind: they’ve assumed greater responsibility for ensuring financial stability since 2008, but risk destabilising markets because investors are so skittish about the possibility of rising interest rates.
Meanwhile, new regulations forcing banks to hold more capital, reduce risk-taking and scale back market-making activities are squeezing liquidity from fixed income markets, exposing them to greater dislocation.
U.S. Treasuries in October last year, the Swiss franc in January this year and German government bonds in April were the epicentres of market events that rippled across the world but only lasted a day or two.
The turmoil of August 24, again sparked by worries over China and including a 1,000 point plunge in the Dow Jones Industrial Index in just minutes, was also short-lived.
RISK OF A LONGER SHOCK
But what if the next seismic shock lasts longer?
“The key question is not so much whether markets will rise or fall. The issue is the extent to which the financial system can absorb such movements, lick its wounds and resume,” said Robert Jenkins, Senior Fellow at Better Markets and a former member of the BoE’s Financial Policy Committee.
“Seven years on from (the collapse of) Lehman (Brothers that triggered the financial crisis) the banking system remains excessively leveraged and central bank policies continue to prompt savers to take risks they are ill-equipped to take.”
State Street Global Advisors’ research into returns of major equity and bond indices shows that in 2015 there have been 42 highly turbulent days, where volatility has been in the top ten percent of readings over the previous five years, versus only 11 last year and 94 in 2008.
The turbulence is even greater in foreign exchange, with unprecedented volatility in some emerging currencies. For example, Brazil’s real lost a quarter of its value in two months before soaring 6 percent on Sept. 24.
According to State Street, there have been 73 “highly volatile” days in FX so far in 2015, more than double the number in 2014 and on track to reach the 104 registered in 2008.
The BoE said on Thursday the financial system’s resilience was improving but downside risks had risen.
The same day, the EU’s European Systemic Risk Board said low global interest rates and risk premia were “one common driver of the current risk situation.”
IS THE FED PART OF THE PROBLEM?
The U.S. Federal Reserve injected another dose of volatility against that backdrop this month, intentionally or otherwise, by passing on the chance to raise interest rates for the first time since 2006.
“In the face of the volatility, they blinked,” said Michael Metcalfe, head of global macro strategy at State Street Global Advisors in London.
Second-guessing the Fed has become increasingly difficult and many observers say that, because it has delayed moving on rates so much, it is contributing to the problem.
New York Fed President William Dudley said in May last year he was nervous that investors were too complacent about unusually low volatility, potentially sowing the seeds for disruptive market moves.
Higher volatility has certainly ensued, and not just in the obvious places, as Monday’s Glencore-driven 17 percent slide in the value of copper producer Zambia’s kwacha currency showed.
Were a market slide to snowball, the Fed and other major central banks would be less equipped to save the day because interest rates are already at or near zero and balance sheets bloated with trillions of dollars of “quantitative easing” bond purchases.
“Markets are telling us they’re unsure what the central bank playbook looks like from here,” said Mark Haefele, global chief investment officer at UBS’s private bank in Zurich with over $250 billion of assets in discretionary mandates.
“Investors have to worry about the Fed getting it right, but also: will Japan, China and Europe get policy right?,” he said. (Reporting by Jamie McGeever; editing by John Stonestreet)
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