Market Volatility Fueled by Factors that Are Somewhat Inconsistent with One Another
June 13, 2013
It’s been a very volatile statement week through Thursday for bonds, stocks, and certain currency relationships like dollar/yen, NZD/USD, and AUD/USD, all of which traded in a high-low band today of 2.7-2.4% in width. Unlike most of the the time since 2007, bonds and stocks have traded the same way. They and commodity prices have been softer on balance.
Major factors behind these corrections are
- Mounting doubts that Abenomics will cure Japan’s deflation and produce a significantly higher trend in real economic growth than experienced over the last two decades.
- Weaker Chinese economic growth that’s running now between 7% and 8%, not 10-11%. That’s like going from a trend of 2.5-3.0% to total stagnation, and it’s happened the the world’s second largest economy. Other developing economies also are experiencing a more pronounced slowdown in duration and size than they did when industrial economies suffered through the Great Recession.
- Fear that engorged central bank balance sheets will lead to a meaningful acceleration of inflation.
- The belief that the Fed will be transitioning out of its accommodative stance sooner and faster than foreseen a few months ago.
- Worries that new asset bubbles will be bursting.
While each of the above concerns has elements of plausibility, it is very doubtful that all of them will play out as assumed. Individual economies and the global economy as a whole is not going to jump from the current era of disinflation to stagnation. Stagnation, a stage of deficient growth and excessive inflation evolves from deeply engrained inflation expectations after prolonged unacceptably high inflation, and it is caused by draconian policy efforts to end demand-pull inflation through induced recession. That doesn’t describe the scene in mid-2013.
It is additionally interesting that investors, on the one hand, expect deflation to persist in Japan, concluding that Abenomics in too many respects is replicating actions that were unsuccessful in the past. And on the other hand, the presumption is made by that the Fed can now proceed with an exit strategy from its quantitative easing as prologue to eventual normalization of interest rates without jeopardizing growth or depressing U.S. inflation further below its medium-term target. To think this is possible is to assume that the U.S. experience will be very different from Japan’s or, for that matter, the effects of the Fed turning off quantitative easing twice earlier. It also neglects the reality of significantly rising bond yields on the mere whiff that QE is being tapered. Yet another dent in this logic is that Fed officials are unlikely to proceed with monetary tightening given the market-induced climb in real interest rates since last autumn as a result of higher nominal rates and lower inflation.
From where I sit, the most compelling reason for the strong pick-up in financial market volatility is that bond and equity prices previously had risen so far with minimal backing and filling. The 10-year Treasury yield posted progressively lower period averages of 7.26% in 1990-94, 6.04% in 1995-99, 4.77% in 2000-04, 4.12% in 2005-09, 3.19% in 2010, 2.76% in 2011, and 1.79% in 2012. The Dow Jones Industrials are currently 132% stronger than on March 9, 2009, and the Japanese Nikkei-225 climbed 80.4% in just 27 weeks through May 22. Over the same span, the dollar soared 31% against the yen only to give back 40% of that advance in the ensuing three weeks.
Copyright 2013, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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