A major monetary policy experiment is under way that will impact asset prices around the world

Christine Rose Photography

  • After falling to near-unprecedented levels last year, volatility in financial markets has increased in 2018.
  • Analysis from Topdown Charts reveals volatility, compared to historic norms, still remains well below average.
  • It says that if quantitative easing (QE) was a force for volatility suppression it’s “pure logic that quantitative tightening (QT) should work in the opposite direction”.

Volatility in financial markets returned with a bang earlier this year, driven initially by inflation concerns, sparked by an unusually large spike in US hourly wage growth in January, before morphing into fears about trade, the Chinese economy and, more recently, emerging markets.

While, for the moment, those concerns appear to have died down, even with the relative tranquility in financial markets over the past week or so, the levels of volatility seen so far this year have been in stark contrast to that seen in 2017 when the combination of stronger, and synchronised, economic growth, coupled with still easy levels of monetary policy, allowed most riskier assets to flourish.

The question now is what will happen next?

Will volatility continue to lift, or is the recent calm a sign of things to come?

No one knows that answer for sure, but based off the chart below, the risks appear to be slanted towards higher volatility in the period ahead.

Topdown Charts

From , it shows the rolling 12-month sum of daily percentage moves of more than 1% across select commodity, currency, bond and stock indices around the world.

Even with the whirlwind price action seen over the past six months, volatility is still incredibly benign, at least compared to the levels seen in prior years.

But Thomas doesn’t expect it will remain that way, suggesting “volatility across asset classes is starting to wake up from a deep sleep”.

While the stage of the economic cycle is one factor that explains the recent uptick in volatility, Thomas says politics, and policy, have been a major driving force behind recent financial market gyrations.

“We can talk about how you should expect higher volatility as the market and business cycles mature, but a big driver is, and will continue to be, politics and policy,” he says.

“We’re in the middle of a major monetary policy experiment of quantitative tightening, or QT.

“If QE was a force for volatility suppression, it’s pure logic that QT should work in the opposite direction.

“So investors need to start thinking about how to deal with this in their investment process, because with greater volatility comes greater opportunity.”

Should Thomas be right it will be welcome news to active investors. However, for passive investors, it could mean a rocky road ahead.

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