MARKETS HAVE BEEN extremely volatile, in the context of a sharp increase in risk aversion and flight to safety.
To some extent, some increase in volatility was to be expected: after years of policy accommodation, it shouldn’t be surprising that the road to normalisation is characterised by a few bumps. But the recent heightened volatility may be signalling deeper concerns. In fact, the turmoil has been intense and broad based, hitting commodities, equity markets, and banks, with advanced economies being particularly impacted.
My sense is that this turmoil partly reflects an element of correction of past excesses in financial valuations. But it also points to a more general reassessment of risks related to global growth and stability.
In particular, it is a sign that financial markets are pricing in increasing risks of falling into a scenario of considerably slower nominal growth, as well as diminishing confidence on the ability of policies in advanced economies to keep things on the right track.
Four main factors that have been driving these risk perceptions: worries about global growth and the inflation outlook; uncertainty about China; falling commodity and oil prices, together with the feeling that they are having a larger-than-expected negative impact on commodity- and oil-exporting countries, and a smaller-than-expected positive impact on many importing countries; and concerns about banks in advanced countries.
These factors fall on fertile grounds and exacerbate preoccupations regarding a pre-existing triad of challenges facing policymakers: increasing vulnerabilities in emerging markets, persistent legacies (such as high leverage) from the crisis in advanced economies, and financial market fragilities.
Not only do these concerns contribute to high market volatility, but they also point to higher risks of a derailed recovery, at a moment when the global economy is highly vulnerable to adverse shocks.
In light of all of this, are the current policy responses sufficient to manage these challenges and to address the gloom that has enveloped financial markets recently? More needs to be done to achieve what I will call the “Great Normalisation”, thus avoiding further market dislocation. I will argue that to succeed policymakers need to adopt urgently more comprehensive and concerted policy action to strengthen growth and manage vulnerabilities. The cost of inaction is high, as markets are signalling their restlessness with the status quo.
Against the background of a disappointing and fragile recovery, global financial stability is far from assured.
At the global level, the financial regulatory reform agenda should be completed and implemented. As part of this, the resilience of market liquidity should be reinforced by putting in place adequate policies and oversight of asset management and financial market structures. That is, turning shadow banking into a stable source of market-based finance. This is crucial to safeguarding global financial stability and supporting global growth.
Finally, collective effort should also focus urgently on further enhancing the global financial safety net and strengthening oversight to better manage the risks associated with capital flows. In particular, there may be a need to consider new financing mechanisms to address the risks faced by commodity exporters and emerging markets with strong fundamentals but high vulnerability to spillovers.
José Viñals is financial counsellor and director of the International Monetary Funds’ monetary and capital markets department.
