Central banks abet the complacency they fret about

June 4, 2014

By Swaha Pattanaik

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

It is commonplace for central bankers to protest against violent price swings, but these days they are concerned that markets are too placid. New York Fed President William Dudley, European Central Bank Governing Council member Ignazio Visco, and Bank of England Deputy Governor Charlie Bean have all recently expressed disquiet about very low volatility. They are right to worry, but in casting blame, policymakers need to look in the mirror.

Almost six years of cheap money from central banks have buoyed the prices of a range of assets and progressively dampened two-way market gyrations. In turn, calmer actual conditions have depressed expectations of how much prices will move in the future. Market participants now count on prices being so placid that many measures of expected stock, bond or currency volatility are below averages that prevailed in the four years before the financial crisis.

The less investors fear sharp setbacks, the more they fixate on hunting down better returns. This shows up as demand for riskier, and less liquid, debt. It fuels appetite for equities at ever richer valuations. And it tempts investors to use borrowed money to place bets, as the ECB’s most recent Financial Stability Report points out. In the foreign exchange market, carry trades, which involve borrowing low-yielding currencies to invest in higher-yielding ones, are back in vogue.

With so many betting on the same outcome, small setbacks could quickly turn into routs. And any lurch lower in prices will be more pronounced, since regulation and other factors have reduced market liquidity, even in frequently traded assets such as government bonds.

The problem is that central banks are perpetuating the problem they identify. The U.S. Federal Reserve is still buying assets, albeit at a slower pace. The ECB, whose crisis-era loans were used by banks to buy peripheral euro zone debt, is poised to ease again. Their actions may be justified by economic considerations. But it is little use telling investors to beware low volatility as long as policy promotes it.

Comments

OK, Let me get this straight:

First the Fed creates a stable economy with slow growth (as opposed to no growth or negative growth).
Then, Traders and some investors get greedy and reach for yield via high risk investments.

Then, when those investments crash – which they invariable do — it is Fed’s fault???

That’s TeaParty logic if I ever heard it! Whenever bad things happen, it is ALWAYS the fault of government. Get rid of government! It’s no good!!!

ROFL…

Posted by GeorgeBMac | Report as abusive
 

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