Core markets remain calm despite equity volatility

The dislocations in financial markets caused by the coronavirus shock have now largely disappeared and, while there may be further bouts of volatility as the global economy continues to recover (such as yesterday’s sell-off in US tech stocks), our view remains that central bank backstops will prevent a repeat of the March market panic. This view underpins our forecast that risky assets will gain further ground.

Since we published our first Financial Markets Stress Monitor at the height of the market turmoil back in March, all the main stress indicators that we track have improved significantly. Most have now returned to levels not far from where they were before the pandemic. (See Chart 1.)

• Core funding markets have normalised thanks to generous liquidity injections by central banks and the reactivation of the Fed’s dollar swap lines. Volatility in the Treasury market has fallen below its pre-crisis level as the Fed has signalled that it will leave monetary policy ultra-loose for the foreseeable future.

• Corporate and sovereign credit spreads, as well as implied volatility in equity and currency markets, have also declined significantly since March. Their current levels are not particularly high by historical standards, even though they remain a bit higher than before the crisis. In our view, that reflects continued uncertainty about the future path of the pandemic, as well as the outcome of the upcoming US election.

• Money market conditions have continued to improve and use of the Fed’s backstop facilities has fallen.

• Market liquidity has normalised in most cases, although volatility in US equities has ticked up recently.

• Bank equities have under performed the broader market, but their credit default swaps (CDS) premia have continued to fall back.

• Among DM sovereigns, strains in the euro-zone periphery have eased further.

• Pressure on EM sovereigns has generally continued to ease, but Turkey remains a key exception.

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