Frequent u-turns in the Fed’s policy stance, central banks’ lack of monetary policy credibility, currency wars and gyrations in macro data are being blamed for financial market volatility and record lows in government bond yields. The forthcoming EU referendum has also buffeted UK financial markets.
But on the whole, financial markets and macro data have since 1 April showed a far greater degree of stability than in preceding quarters.
US interest rate, equity and currency markets have weathered the gyrations in the Fed’s policy stance and the ebbs and flows in US data. German and Japanese government bond yields have fallen but ultimately been less volatile than in Q1. The World Equity Index has also been constrained in a reasonably narrow range, thanks at least in part to signs that global GDP growth stabilised in Q1.
This relative stability has not been confined to the dollar. So far, Q2 2016 has been the least volatile quarter since January 2015 – as defined by the low-high range using daily data – for most major nominal effective exchange rates (NEERs). These include developed and EM currencies, as well as commodity and non-commodity currencies. Among G7 currencies, the euro NEER has been particularly stable in a 2.1% range.
The picture is also one of relative calm in emerging markets, with the pick-up in foreign capital inflows in April and June and in commodity prices since March helping to stabilise EM currencies without central banks having to draw on still significant FX reserves.
Commodity prices, including crude oil, have risen sharply so far in Q2 but their volatility has remained in line with historical standards, particularly in recent weeks. This has contributed to greater stability in commodity currencies, with the exception of the Australian dollar.
If anything, this lack of directionality has forced financial market players to be light-footed and adopt short-term tactical strategies. The question now is whether this relative calm is here to stay or whether it augurs more violent corrections as was the case earlier this year.
The UK referendum on EU accession has the potential to be far more destabilising to financial markets than the BoJ’s policy meeting on 16 June and in particular the Fed’s meeting the day before. While UK markets would likely feel the brunt of a decision to leave the EU, the euro would also likely weaken and global equity markets conceivably sell off.
The Fed’s policy meeting on 27th July could also prove disruptive at a time of potentially reduced summer-liquidity.
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