We should not be frightened of a return to volatility in the markets – provided it can be managed

Economic View: Good news comes in a gradual stream while bad news comes in chunks

It's quiet – too quiet. You know the classic movie scene where the hero observes how quiet things are just a moment before all hell breaks loose? It's a bit like that on the financial markets just now. Whether there is some shock about to hit us is anyone's guess, but the lack of volatility in the markets is quite remarkable. Shares in the developed world are pretty flat, currencies are pretty flat, bonds are pretty flat and most commodities are pretty flat too.

For anyone who makes money out of volatility, such as the shareholders of IG Index, the UK's largest spread-betting firm, this is already bad news. It noted a couple of weeks ago, when it produced its results, how subdued trading had been. It was also a key part of a recent speech at the LSE by Charlie Bean, a deputy governor of the Bank of England, on the future of monetary policy – how we get back to normal. He showed one of those spider's web graphs, reproduced here. This demonstrates that volatility in a number of different markets was much higher during the financial crisis (the red ring) than it was beforehand (the blue ring), as you would expect. But since the February Inflation Report it has been even lower than it was before the crisis (the black ring).

"Taken in isolation," he observed, "this is eerily reminiscent of what happened in the run-up to the crisis."

Another measure of volatility is the Vix, the so-called "fear gauge". This is the Chicago Board Options Exchange Volatility Index and it reflects a market estimate of future volatility based on the weighted average of the implied volatilities of a number of different markets. This is currently the lowest it has been for a year, and as you can see from the second graph, it has fallen further since February.

Why so quiet? There are two broad explanations and the answer will encompass some mix of them both.

One is investors can see that the world economy is in the early stages of a cyclical recovery. Although different countries are moving at different speeds – the UK, US and Germany well into it, France, Italy and Spain well behind – the recovery has a long way to run. Growth will enable countries/markets/companies to work through any difficulties they might face. This combination – an awareness that a lot needs to be fixed but also a confidence that it can be fixed – explains the calm in the markets. Both the good news and the bad are, so to speak, "in the market".

The other explanation, cited by Mr Bean in his speech, is that there is "a sense of complacency and an underestimation of market risk by investors". He continued: "It is inevitable that at some stage market perceptions of uncertainty will revert to more normal levels. That is likely to be associated with falls in risky asset prices and could be prompted by developments in Ukraine, the fault lines in the Chinese financial sector, monetary policy exit in the advanced economies, or something else. But it will surely come at some point."

It is implicit in that statement that the shock will be a negative one and given present level of asset prices this is probably right. Louise Cooper, the independent analyst, put out a post yesterday drawing attention to the way American investors were seeking protection against a fall in share prices: the ratio of "puts" relative to "calls" was at its highest level since 1955. Many more people were betting that the market would fall rather than rise.

That is certainly the balance of probability. But we should not exclude the possibility that the surprises will be positive ones: that the breakout will be on the upside, not the down. It is harder to make this case, largely because the world being what it is, good news comes in a gradual stream while bad news comes in chunks. It will be interesting to see today's statement by the European Central Bank, both for what it proposes and the market reaction to it. Expectations are very high and that itself must be a concern; but the ECB president, Mario Draghi, is not someone you want to bet against. If the negative surprises that might break this period of low volatility are the usual suspects noted by Mr Bean, the positive surprises must include better-than-expected performance from the eurozone.

For the US, the main positive surprise would be for employment to pick up. The rate of hiring has been unusually slow, given the OK economic performance. If that were to happen it would underpin rising consumption and spread the benefits of the recovery more widely.

And here in the UK? Well, all the data are very positive, particularly the prospects for employment growth (the CBI survey yesterday was strong) and the monetary indicators. Narrow money is pointing to good growth for the rest of this year. The question really is not about the economy, but about how much of the positive stuff is in the market already, and how seriously political risk is weighing on sentiment – political risk including the Scottish referendum as well as the general election next year.

One final thought. There is an implicit assumption that volatility in financial markets is bad and stability is good.

On the face of it that is true: you absolutely don't want the level of volatility associated with the financial crisis. But a return to more bumpy markets would create opportunities for companies as well as investors. We certainly should not be frightened of it, which is a good thing because that is what we shall surely get.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Content Writer - Global Financial Services

£25000 - £30000 per annum: Recruitment Genius: From modest beginnings the comp...

Recruitment Genius: Web Developer - PHP

£35000 - £40000 per annum: Recruitment Genius: From modest beginnings the comp...

Recruitment Genius: Field Sales Consultant - Financial Services - OTE £65,000

£15000 - £65000 per annum: Recruitment Genius: This is an exciting opportunity...

Recruitment Genius: Loan Underwriter

£18000 - £20000 per annum: Recruitment Genius: This is a fantastic opportunity...

Day In a Page

A nap a day could save your life - and here's why

A nap a day could save your life

A midday nap is 'associated with reduced blood pressure'
If men are so obsessed by sex, why do they clam up when confronted with the grisly realities?

If men are so obsessed by sex...

...why do they clam up when confronted with the grisly realities?
The comedy titans of Avalon on their attempt to save BBC3

Jon Thoday and Richard Allen-Turner

The comedy titans of Avalon on their attempt to save BBC3
The bathing machine is back... but with a difference

Rolling in the deep

The bathing machine is back but with a difference
Part-privatised tests, new age limits, driverless cars: Tories plot motoring revolution

Conservatives plot a motoring revolution

Draft report reveals biggest reform to regulations since driving test introduced in 1935
The Silk Roads that trace civilisation: Long before the West rose to power, Asian pathways were connecting peoples and places

The Silk Roads that trace civilisation

Long before the West rose to power, Asian pathways were connecting peoples and places
House of Lords: Outcry as donors, fixers and MPs caught up in expenses scandal are ennobled

The honours that shame Britain

Outcry as donors, fixers and MPs caught up in expenses scandal are ennobled
When it comes to street harassment, we need to talk about race

'When it comes to street harassment, we need to talk about race'

Why are black men living the stereotypes and why are we letting them get away with it?
International Tap Festival: Forget Fred Astaire and Ginger Rogers - this dancing is improvised, spontaneous and rhythmic

International Tap Festival comes to the UK

Forget Fred Astaire and Ginger Rogers - this dancing is improvised, spontaneous and rhythmic
War with Isis: Is Turkey's buffer zone in Syria a matter of self-defence – or just anti-Kurd?

Turkey's buffer zone in Syria: self-defence – or just anti-Kurd?

Ankara accused of exacerbating racial division by allowing Turkmen minority to cross the border
Doris Lessing: Acclaimed novelist was kept under MI5 observation for 18 years, newly released papers show

'A subversive brothel keeper and Communist'

Acclaimed novelist Doris Lessing was kept under MI5 observation for 18 years, newly released papers show
Big Blue Live: BBC's Springwatch offshoot swaps back gardens for California's Monterey Bay

BBC heads to the Californian coast

The Big Blue Live crew is preparing for the first of three episodes on Sunday night, filming from boats, planes and an aquarium studio
Austin Bidwell: The Victorian fraudster who shook the Bank of England with the most daring forgery the world had known

Victorian fraudster who shook the Bank of England

Conman Austin Bidwell. was a heartless cad who carried out the most daring forgery the world had known
Car hacking scandal: Security designed to stop thieves hot-wiring almost every modern motor has been cracked

Car hacking scandal

Security designed to stop thieves hot-wiring almost every modern motor has been cracked
10 best placemats

Take your seat: 10 best placemats

Protect your table and dine in style with a bold new accessory