Fed's Market Moves May Ignite Volatility Wall Street Craves, Goldman Predicts
Even this year's Nobel Prize winner is flummoxed by the decline in market volatility.
By Bradley Keoun
Oct 18, 2017
U.S. President Donald Trump's tweets haven't done it. North Korean leader Kim Jong-Un's nuclear threats haven't either. Nor have allegations that Russia attempted to interfere with U.S. elections.
Virtually nothing has been able to jolt global markets out of this year's stupor, characterized by unusually low daily price swings, or volatility, in stocks, bonds and commodities.
Now Goldman Sachs Group Inc. ( GS - Get Report) CFO Martin "Marty" Chavez thinks he knows what might: the Federal Reserve beginning to pare some of the $4 trillion-plus in Treasuries and other bonds on its balance sheet.
While the Fed, led by Chair Janet Yellen, telegraphed how the assets would run off before starting the process this month, traders have scant experience in navigating markets when the U.S. central bank is withdrawing this type of monetary stimulus in such a massive way. That's partly because former Fed Chair Ben Bernanke's effort to shore up financial markets following the 2008 crisis by buying trillions of dollars of bonds -- known as "quantitative easing" -- was also unprecedented in its size and scope.
It's an important question for Goldman Sachs investors, since the firm's juggernaut trading operations depend so heavily on client transactions to generate fees and take the other side of market positions. New York-based Goldman, one of the top Wall Street performers in recent decades, has seen its revenue from trading stocks and bonds plunge this year, in some cases even more than big rivals like JPMorgan Chase & Co.
"Unwinding quantitative easing is unprecedented territory," Chavez said Tuesday on a conference call with analysts and investors. "You could see volatility and spikes showing up in this process simply because it's never happened before."
The Chicago Board Options Exchange's Volatility Index, or VIX, known as Wall Street's "fear gauge" because it typically rises when traders are nervous, has declined so dramatically that some big money managers are raising funds to bet on a rebound, Bloomberg News reported this week.
A rough gauge of how widely traders expect the Standard & Poor's 500 Index to swing on a daily basis over the coming 30 days, the VIX has traded below 11 for much of the past six months, representing (via some tricky math) daily swings of 0.7%. That's about half of the market's 10-year average.
On Tuesday, the VIX traded at 10.31, according to FactSet.
Some economists speculate that the flood of money into markets in the past decade from the Fed, European Central Bank and Bank of Japan has made it nearly impossible for asset prices to fall -- despite multiple reasons for them to do so.
Yet University of Chicago Economist Richard Thaler, who just won the Nobel Prize for economics, told Bloomberg Television in an interview last week that even he's "puzzled" as to why volatility is so low. "When investors are nervous, they're prone to being spooked, and nothing seems to spook the market," Thaler said.
The unwinding of the Fed's balance sheet could be big enough -- and unprecedented enough -- to do that.
Chavez noted that the Fed has been very explicit on its plans. The central bank is allowing a maximum of $10 billion a month of Treasuries and mortgage-backed securities to mature without reinvesting the proceeds. The monthly amount will increase by $10 billion every three months afterward until it reaches $50 billion a year from now.
That being the case, Chavez noted, "We don't see underlying risk priced into the markets." |
