Financial markets have been whipped up over the past week, with the Omicron coronavirus variant sweeping the world just as the Federal Reserve signaled its willingness to accelerate the tightening of US monetary policy.
Dizzying swings in global stock markets wiped billions of dollars in valuations only to partially reverse hours later – changes that underscore how investors must now navigate an increasingly cloudy global economic outlook.
The jolt in volatility underscores how well investors are preparing for the start of the Fed’s withdrawal from its massive stimulus package, which has helped propel stocks to record highs. A new strain of coronavirus has upped the ante in a year when investors poured hundreds of billions of dollars into stocks.
âUncertainty increases volatility, which can cause people to stay on the sidelines,â said Katie Koch, co-head of fundamental equities at Goldman Sachs Asset Management. “We have markets that have very demanding valuations and they have a lot of good news, so when the news flow turns slightly negative it can be disruptive.”
Traders and asset managers have been enthralled by the changes by the Fed, which in November began to reverse policies it put in place to appease markets amid the coronavirus crisis last year .
The spread of the new variant of the Omicron coronavirus threatened to complicate the Fed’s withdrawal, potentially undermining the economic recovery that had given the US central bank the confidence to curb its stimulus package as it focuses on the threat high inflation.
Fed Chairman Jay Powell this week expressed his commitment to continue slowing the pace of the central bank’s $ 120 billion-per-month bond buying program, a process that began last month. He also pointed out that high levels of inflation may also justify a faster decrease.
This back-and-forth, along with reports that offered conflicting views on both the strength of existing vaccines against the Omicron variant coronavirus and the severity of illness caused by the virus, fueled dramatic gains and losses. on the US stock markets.
Investors found themselves grappling with conflicting forces, with tighter financial conditions – caused in part by market volatility – colliding with fears that the spread of the Omicron variant could dampen economic growth, which is usually a sign an easing of monetary policy.
“What the Fed is doing, what’s going on with politics and what’s going on with the economy, all of this supports the idea that volatility is going to increase,” said Matt Freund, co-chief investment officer at Calamos Investments. .
Measures of equity turmoil this week hit their highest since February, with volatility in the $ 22 billion Treasury securities market – the backbone of the global financial system – now at its highest since the March turmoil 2020.
The benchmark US stock index S&P 500 recorded its largest intraday price change since March on Wednesday, as the broad market gauge suffered its worst two weeks of losses in more than a year. And the daily moves were particularly powerful: For three consecutive trading sessions, the S&P 500 moved 2% or more between its highs and lows of the day, a streak that didn’t happen all the time. the year.
While the United States has been at the center of the recent market turmoil, volatility has also increased in Europe. A measure of expected volatility in 50 blue chip eurozone stocks on Friday last week hit its highest level in a year and remained elevated. Similar indices for Hong Kong’s Hang Seng Index and Tokyo’s Nikkei 225 also rose.
In addition to the uncertain economic landscape, investors are also grappling with difficult business conditions during the holiday season between the Thanksgiving holiday in the United States and Christmas.
Typically, this is a time of year characterized by lower trading volumes and a reluctance of fund managers to place large bets, preferring instead to take risks on the table and record profits before the end of the market. the year.
“A lot of people don’t want to trade at this point [of the year] and volumes may be lower, which can increase volatility and increase the magnitude of those movements, âsaid Jason Hedberg, global head of equity derivatives sales at UBS.
Greg Boutle, derivatives strategist at BNP Paribas, added that the rise in volatility was likely feeding on itself, as volatility-sensitive hedge funds that automatically adjust their exposure are likely to reduce their positions. It’s the selling that can make a downturn worse.
Fund managers also said the large brokers they typically trade with have increased the cost of executing large trades, as they prepare to hedge against any fallout if volatility remains high and markets fall.
In turn, some investors protect their portfolios – or make direct bets – on extreme risks, or unlikely but hard-hitting events that could bring stock markets down.
John Brady, managing director of RJ O’Brien, said guarding against oversized movements in the stock markets has regained importance now that the Fed’s crisis measures, which had supported asset prices, were starting to take a hit. be withdrawn.
This was demonstrated on Friday, when the derivatives markets turned on again. Investors have traded over 26 million put options – contracts that can pay off if a security’s price drops. It was the second-highest level on record, only one day behind in February 2020, when global financial markets began to take into account the coronavirus pandemic.
Others, like Goldman’s Koch, say they are using dislocations to adjust portfolios, given that some of the declines seem exaggerated.
This divergence between fund managers means that as the final trading days of the year approach, investors are bracing for other bouts of volatility to come.
For John Leonard, global head of equities at Macquarie Asset Management, the market swings are reminiscent of similar events just three years ago, when a Christmas Eve liquidation bruised stocks.
âThis is the natural consequence of the combined events of the emergence of the Omicron variant and the Powell pivot,â he said. âThe combination of these two things created volatility. You’re going to have to wait for the dust to settle.
Additional reporting by Madison Darbyshire in New York
Not covered – Markets, finance and strong opinion
Robert Armstrong dissects the most important market trends and explains how the best minds on Wall Street are reacting to them. Sign up here to receive the newsletter straight to your inbox every day of the week