A spot of turbulence
20 February 2018
Everything was perhaps going a little too smoothly. Global growth looks to be on track to hit a multi-year high in 2018, helped by a broad upswing across developed and emerging economies. Labour markets continue to heal from the long lasting fallout after the financial crisis. Central banks across a range of economies have started to signal a very gradual withdrawal of their still accommodative policy settings as conditions improve. However, the mood in markets soured notably at the start of February, despite few signs of interruption to these good news stories. The MSCI global equity index lost 9% of its value in the space of a week, credit spreads pushed wider (particularly in high yield markets), commodity prices dipped, capital flowed out of emerging markets and investors moved into safe haven currencies like the Japanese Yen.
The market narratives amid this rising stress were mixed. Some commentators warned that rising inflation would require a more abrupt adjustment in monetary policy. Others were concerned that higher term premia would tighten financial conditions and choke off the recovery. Interestingly, these were both risk scenarios that we identified in our upbeat 2018 outlook. However, we see few signs that these are crystallising at present. The inflation environment looks to be contained across most markets, even in the US where we would be wary of over-interpreting the latest wage and inflation data. Similarly, while government bond yields have been rising, this looks to be in part due to improving economic conditions, alongside moderate increases in term premia. Context might be a better way to explain the recent market stress. Before the correction global equities were up some 26% over the past year, and 49% over the past two years. Against this backdrop, the early February adjustment looks less malign. Indeed, the market has already calmed, with risk assets partly retracing their losses. Our financial stress index also puts this move into perspective (see Chart 1). The episode reflects a sharp, but short lived, spike in volatility from unusually low levels, which is unlikely to be severe enough to dent growth. Policymakers will feel comfortable looking through this bump, as long as they do not see evidence that the underlying fundamentals are shifting.