A recent article from the Bank for International Settlements Monetary and Economic Department points to increasing volatility and uncertainty in the currency markets as signs of the increasing fragility of major global equity markets. The BIS article also highlights the global low-economic growth environment, and notes the bull market of the last several years has been supported by “unusually accommodative monetary policies in advanced economies”, policies that aren’t likely to change anytime soon, but that can’t last forever.
Equity markets over-reaction to news becoming commonplace
According to the BIS analysts, a number of recent developments in major equity markets hint at their increasing fragility.
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They note: “Global equity markets plummeted in early August and mid-October. Mid-October’s extreme intraday price movements underscore how sensitive markets have become to even small surprises. On 15 October, the yield on 10-year US Treasury bonds fell almost 37 basis points, more than the drop on 15 September 2008 when Lehman Brothers filed for bankruptcy. Market movements were particularly sharp during a 20-minute window when yields slipped and then rose by around 20 basis points. These fluctuations were large relative to actual economic and policy surprises…”
Macroeconomic divergences may worsen the situation
The BIS article also argues that the recent volatility in the equity markets is related to growing worries about the global economic outlook and spiking geopolitical tensions. Recent manufacturing purchasing managers’ indices suggest an economic slowdown, especially in Europe.
They note: “Markets were particularly surprised by data for Germany, where the widely watched Ifo Business Climate Index fell almost to a two-year low in October. Markets were also affected by the IMF’s bleak forecast for the global economy that identified other weak spots, including Japan, China and major emerging market economies (EMEs). One major exception to this softer macroeconomic outlook was the United States, where recent data pointed to a more sustained recovery.”
Another economic divergence that is spooking the markets is the fact that that price of oil and most other commodities continued to fall sharply. This is partly due to weaker global growth, but additional supply coming on line is also a factor, especially for oil.
The article argues that “the overall impact on the global economy of lower commodity prices is likely to be positive.” The BIS analysts suggest that commodity-importing countries in will start to see significant improvements in their current accounts and savings from lower costs for energy subsidies. Equity markets in commodity-exporting countries, especially those with weaker macroeconomic fundamentals, such as Brazil and Russia, are already suffering.
Diverging macroeconomic developments are also reflected in diverging monetary policy actions. The U.S. Federal Reserve ended its long-running QE program on October 29th, and it seems almost certain that the European Central Bank will begin some type of quantitative easing here in the near future.