Great Moderation 2.0 Seen Lasting by JPMorgan Until Fed Shifts

The calm that has descended on financial markets has longer to run if history is any guide.

Having coined the phrase Great Moderation 2.0 to describe the lull back in April, JPMorgan Chase & Co.’s John Normand is comparing this moment to periods of tranquility over the past three decades.

His findings suggest the quiescence is here to stay for a while, meaning investors may be lulled into taking ever-greater risks.

The bank’s head of foreign-exchange and international-rates strategy in London characterizes low volatility in the currency market as when swings in the Group of 10 major currencies slip and stay below 7 percent on a trailing three-month basis.

While that happened for 45 business days as of the end of last week, the average timeframe of similar episodes since the 1980s is 150 days. They ranged in length from three months when the Federal Reserve paused its easing of monetary policy in 2002 to almost two years during the so-called Goldilocks era of the late 1990s when the U.S. economy was neither too hot nor too cold.

“The current undershoot is quiet immature by the historical norm,” Normand wrote in a June 6 research note.

More often than not, the Fed is the key. The last market lull ran for 156 business days and ended in May 2013 with the “taper tantrum” when Fed officials began suggesting they would soon start slowing monthly asset purchases.

“As most would acknowledge, central bank predictability is bearish for volatility,” he said. “The current backdrop is textbook.”

This time, the calm may continue unless U.S. inflation data or wage pressures force the Fed into tightening policy sooner than markets anticipate or if a geopolitical crisis blows up, said Normand. A Bloomberg News survey of economists in May suggested the consensus doesn’t expect the Fed to raise its benchmark before the third quarter of next year.

Until these risks emerge “this vol undershoot has further to run,” he said.