Volatility in the financial markets is likely to continue for some time to come, according to one of the speakers at Room151’s latest Monthly Online Treasury Briefing (MOTB).
Cameron Shaw, senior portfolio manager at Ardea Investment Management, said that the “one-in-a-hundred-year event” experienced in the gilt market following the UK’s mini-budget was unlikely to be repeated. However, general volatility would be an ongoing problem across financial markets.
“Governments were volatility suppressors, but now they are creators. You will see a lot more volatility in bonds in the traditional safe havens and in equities in general going forward,” he said.
In a presentation to the briefing entitled ‘Stretched to breaking point’, Shaw compared the performance of different asset classes over the first half of 2022. He pointed out that nearly all major asset classes had posted sizeable losses during this period.
It saw the worst return for the first half of the calendar year for the S&P500 since 1962, for US High Yield Credit since 1989, the Japanese Yen since 1989 and US 10-year Treasury bonds since the 1970s.
You will see a lot more volatility in bonds in the traditional safe havens and in equities in general going forward.
Nowhere to hide
“This year has been a very volatile period in financial markets. Outside commodities and the US dollar, there has been nowhere to hide,” Shaw said.
“There have been huge drawdowns in equities, credit markets, emerging markets, every asset class you can think of. And even worse year-to-date losses than in the financial crisis in 2008.”
Shaw suggested that the situation had been caused by unexpected high levels of inflation across the globe forcing central banks to hike interest rates. This aggressive tightening meant that traditional safe havens, such as government bonds, suffered “equity-like” drawdowns.
“Why did this happen? It was because central banks had their heads in the sand this time last year. They were assuming that inflation was transitory, which was clearly not the case,” he said.
Central banks were “massively behind the curve and were forced to play catch-up”, Shaw told attendees to the briefing.
Central banks had their heads in the sand this time last year. They were assuming that inflation was transitory, which was clearly not the case.
Unfunded fiscal stimulus
In the UK, “petrol was thrown onto the fire” by the mini-budget of 23 September, which promised a large, unfunded fiscal stimulus at a time when inflation was already a problem.
This caused a sell-off of bonds and an increase in yields of 200 basis points in the space of a few days. As a result, the Bank of England was forced to announce that it would temporarily buy bonds with the aim of calming the market.
UK gilt yields have now returned to the levels seen before the mini-budget. But Shaw suggested that inflation had not yet peaked, and the likelihood was that central banks would now “overtighten”.
“Central banks will err on the side of too much tightening. So unlike this time last year when they were behind the curve, they are actually ahead of the curve.”
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