Seatbelts fastened for Volatility 2.0

Brian Tomlinson
Written by

30th November 2015

The declining liquidity in the bond markets has been a hot topic for a few years, creating air pockets and making prices vanish as volatility increases…with a frequency that is marking a turning point in markets’ history. Indeed we seem to have entered a new, turbulent era: the era of volatility 2.0.

A picture is worth a thousand words:

image2

The volatility of volatility as shown on the above graph has been steadily rising since 2008….even if events are less “earth moving” relative to other historical events. Indeed, the recent Fed/China events have triggered a much stronger reaction than the Lehman Brothers collapse…which can look out of proportion.

When did the era of Volatility 2.0 start?

Clearly during the 2008 financial crisis, when a new banking regulation appeared. Here is a brief summary of the consequences of this new regulation:

image3-2

Question: Is this new era good or bad news for us active asset managers?

Answer: Where others see risks, we see opportunities. What happens to fixed income markets when a new peak of volatility arises? The flight to safety makes government bond prices surge, while corporate and emerging market bond prices get cheaper. In other words…what occurs is a spread widening. We fund managers can then buy these cheaper assets by selling our “liquidity buckets” (i.e. cash or liquid government bonds).

– The future –

Question: What will happen when the lack of bond market liquidity is confronted with the Fed when it begins to hike rates in December – the first rate hike in about 8 years – and what lies ahead?

The answer is twofold:

*Short term: My opinion is that the Fed rate hikes are already discounted, and that the Fed being confident enough to raise rates will send a positive signal to investors…getting investors ready to buy risk and conduct asset allocation.

*Longer term: We need to fasten our seatbelts and get ready for more volatility. Since the new regulation is here to stay, asset managers will most probably make higher use of derivatives to flexibly adjust their risks through futures and options. They will also probably turn more and more to brokers, who might become the new intermediary, replacing the banks who have stepped out of this role.

Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested.   

Past performance is not a reliable indicator of future results. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor’s local currency.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or wilful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail.  

This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). The information contained herein is confidential. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted.