Central Bankers Who Bemoan Low Volatility Share Blame, BIS SaysDavid Goodman and Sofia Horta e Costa
Central bank policy makers have expressed concern this year that low market volatility is masking future risks. In fact, they’re helping cause the issue they bemoan, the Bank for International Settlements said.
Record-low interest rates and unconventional monetary easing by the Federal Reserve, European Central Bank and the Bank of Japan reduced price swings across markets, the BIS wrote in its annual report published today. That’s prompted investors to take greater risks to maintain returns, even amid an uncertain global recovery, according to the BIS, which acts as a central bank for the world’s monetary authorities.
After pumping billions of dollars into the global economy to end the financial crisis, central bankers say the new calmness makes them uneasy, because it can turn investors complacent, increasing chances for future market instability. The evidence is unprecedented: A risk measure that uses options to forecast fluctuations in equities, currencies, commodities and bonds fell to its lowest level on record last week.
“Throughout the year, accommodative monetary conditions kept volatility low,” the Basel, Switzerland-based BIS said in the report. “By mid-2014, investors again exhibited strong risk-taking in their search for yield. Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.”
Last month, Federal Reserve Bank of New York President William Dudley said the slide in market volatility “makes me a little nervous.” Bank of England Deputy Governor Charlie Bean said conditions were “eerily reminiscent” of the pre-crisis era.
Bank of America Corp.’s Market Risk Index closed at minus 1.31 on June 26, the lowest level since at least 2000.
As volatility dropped and interest rates stayed near historic lows, demand for riskier assets increased. Bonds from Europe’s most indebted nations have led a rally in sovereign securities this year, while stocks indexes in the U.S. and Europe have climbed to records.
Greek securities returned more than 30 percent this year through June 26, Bloomberg World Bond Indexes show. Portuguese bonds gained 16 percent and Spain’s added 9.7 percent. The average yield to maturity on euro-area government bonds fell to an all-time low of 1.30 percent on June 26, according to Bank of America Merrill Lynch’s Euro Government Index.
At the same time, Ireland, Portugal and Greece have all held over-subscribed bond sales this year, a marker of the region’s recovery from the debt crisis that froze nations out of capital markets and threatened to splinter the currency bloc.
“We do see risks, despite the fact that the markets are calm,” Bundesbank board member Andreas Dombret said this month. Dombret is also a member of the ECB supervisory board for the Single Supervisory Mechanism that oversees banking policy.
The Standard & Poor’s 500 Index of the largest U.S. stocks closed at its highest level ever on June 20, capping three days of consecutive records. In Germany, the DAX Index breached the 10,000 level for the first time this month, while the Stoxx Europe 600 Index is only 2.2 percent away from a six-year high reached on June 10.
“Monetary policy had a powerful impact on the entire investment spectrum through its effect on perceived value and risk,” the BIS wrote in its report. “ Accommodative monetary conditions and low benchmark yields -– reinforced by subdued volatility -– motivated investors to take on more risk and leverage in their search for yield.”
The rally in stocks and bonds was boosted this month as the European Central Bank cut its deposit rate to minus 0.1 percent, lowered the main refinancing rate to a record 0.15 percent, and announced a further package of unconventional measures to boost growth.
In the U.S., where policy makers are still buying $35 billion of bonds per month, Fed Chair Janet Yellen has said the central bank plans to keep its interest-rate target low for a considerable time after its completes the process of winding down purchases. The Bank of Japan is expanding the monetary base at a pace of 60 trillion yen ($589 billion) to 70 trillion yen per year, having left the program unchanged since implementing unprecedented stimulus in April last year.
“The ECB, which was previously unwilling to undertake unconventional monetary policy, has now said that they are willing to undertake unconventional monetary policy,” James Bullard, president of the Federal Reserve Bank of St. Louis, said on June 26.
“To have such a big central bank essentially come off the sidelines during the first months of 2014 has been a major development on a global scale. I think that contributed mightily to the bond rally so far this year and also to the low-volatility environment.”