January 2016

[admin]

This actually makes sense

Financial markets are undergoing two consequential transitions, which not only amplify the impact of even the smallest developments in China and oil, but also increase risk aversion overall and create the conditions for more unpredictable developments. The first has to do with the shift from a prolonged regime of repressed financial volatility to an environment in which such instability is higher and less predictable. The primary reason is that central banks are less willing (in the case of the Federal Reserve) or less able (in the case of the European Central Bank and the People’s Bank of China) to act as suppressors of volatility. In the short term, this transition inevitably leads to higher risk aversion, deleveraging and lower portfolio risk-taking, especially affecting risk-based models and asset allocations that use volatility as a major input. The second transition involves liquidity, and a move away from counter-cyclical balance sheets. Facing tighter regulation and sharply reduced market appetite for short-term earnings deviations, broker-dealers are a lot less willing to take on inventory when the market overshoots. Other pools of capital, including sovereign wealth funds, also face constraints in increasing their risk-taking.

The Deeper Causes of the Global Stocks Rout - Bloomberg View

The risk is a spill-over from this financial instability to economic instability, but perhaps things calm down before that happens:

Left unchecked, these two transitions would feed each other, accentuating the general sense of financial instability and insecurity. The longer this continues, the greater the volatility and the bigger the threat of adverse consequences for economic and corporate fundamentals; and the higher the risk that the instability could then spill back onto financial markets, fueling a destabilizing vicious cycle of economic and financial dislocations. The good news is that such dynamics ultimately exhaust themselves. Unfortunately, that only happens after a lot of volatility, accompanied by a heightened risk of very sharp and disorderly declines in financial asset prices as well as contagion. In the process, that turmoil has a contractionary influence on corporate and household spending, slowing economic growth.

The Deeper Causes of the Global Stocks Rout - Bloomberg View