Morgan Stanley
  • Thoughts on the Market
  • Nov 13, 2020

An Artificial Calm?

With Andrew Sheets


Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, November 13th, at 2:00 p.m. in London.


My favorite stories in financial markets involve widely believed statements that simply are not true. I'd like to talk about one of these myths today: the idea that very aggressive central bank policy has artificially suppressed market volatility. I don't think this is right. The last several years have actually seen high levels of volatility in the equity and credit markets, high levels that, going forward, we think can decline.


When talking about central banks and market volatility, one often hears something like the following: in the aftermath of the Great Recession, central banks intervened aggressively in financial markets. This intervention overwhelmed all other factors, introducing an unusual, unnatural and artificial calm to the stock market. It's been smooth sailing, but only because of central banks.


But as widely believed as this idea is, the data says something different. Since 2010, a period that has generally seen aggressive central bank support for markets, the S&P 500 has consistently experienced more volatility than it did between 2004 and 2007, a period with no such central bank assistance. Meanwhile, 2020 has seen some of the highest levels of market volatility on record, despite some of the largest central bank interventions on record. Clearly, there's a lot more to this story.


Indeed, while central banks are important forces in the market, the last decade shows that the underlying economy still matters. The greatest market stresses of the last decade; in 2010, 2011, 2015, 2018 and 2020, were all driven primarily by concerns that the economy was slowing.


We think that matters going forward. Morgan Stanley's economists have been optimistic about the global economic outlook, while expectations for future volatility are still relatively high. If the economy keeps improving, those expectations of future volatility may prove too pessimistic, and volatility should moderate closer to long-run averages. Further positive developments on a Covid-19 vaccine, and a reduction in U.S. political uncertainty, may also help.


There is one market where this conventional wisdom about the impact of central banks on volatility is true: government bonds. While expected volatility for the U.S. stock market is pretty similar today as it was on January 1st, 2010, expected volatility in the U.S. Treasury market is much, much lower. If the global economy improves as expected, we'd expect a hand-off. Stock markets becoming less volatile, bond markets becoming more so.


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Confidence in the ability of central bank to suppress market volatility through aggressive policy may be misplaced.

Each week, Chief Cross-Asset Strategist Andrew Sheets, or a member of his team, offers perspective on the forces shaping the markets as well as insights on investment opportunities and risk across global asset classes.

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