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More fragile than volatile

21 October 2014 By Rob Cox

It has been impossible to escape the V-word for the past week. Turn on the television, and it is easy to conclude that central bankers, corporate chiefs, investors and politicians think volatility is the biggest problem vexing global markets. The rollercoaster ride recently experienced by financial assets is nettlesome. But it’s merely a symptom of a bigger malady: the fragility of widely accepted assumptions about where the world is headed.

The see-sawing of markets is succinctly illustrated by the Chicago Board Options Exchange Volatility Index, or VIX. It uses the prices of S&P 500 Index options to give an indication of investors’ expectations of near-term swings in the stock market. Conventional wisdom suggests that the higher the index goes, the greater the fear is among investors that markets will forge an unstable path in the weeks ahead.

Market volatility makes it hard for people in the real economy to plan ahead. So, a fund manager fearing zigzagging prices may be better off keeping funds invested in cash. Company executives may hold back on hiring new staff or buying new equipment until things calm down. And central bankers pondering what to do about interest rates may have a change of heart.

On Thursday, James Bullard, president of the Federal Reserve Bank of St. Louis, suggested that the U.S. central bank may need to rethink its plan to finish phasing out its bond-buying effort later this month. While he was responding specifically to diminished expectations of inflation his comments came after the VIX surged to almost 31, its highest level in nearly two years.

Yet obsessing about volatility, rather than examining its underlying causes, would be a mistake. Seen as emblematic of larger problems, volatility is a helpful motivator. The doubling in the VIX from Oct. 8 to last week’s high presents an opportunity to address causes for concern in the global economy, including monetary policy, geopolitics, growth and, at least for the moment thanks to media excitement, health. All have seen events that exposed the fragility of their generally accepted trajectories.

Though it arguably doesn’t belong on the standard dashboard for financial investors, the unfolding Ebola crisis nicely illustrates this. Just weeks ago, the virus was considered a matter of West African regional concern. Even when a carrier of the hemorrhagic malady was discovered in Texas, U.S. health officials delivered soothing reassurances that the disease would easily be contained. In a matter of days, it became clear this confidence was at least somewhat misplaced.

Of course the United States has ample resources to nip an Ebola outbreak in the bud. Nigeria, Senegal and Spain have each achieved as much. But the American public must now grapple with the notion that the Centers for Disease Control and Prevention is fallible. That’s a shock for the many Americans who thought the agency led the world in fending off anything smacking remotely of apocalypse, even the cinematic zombie variety.

If the CDC can screw up – failing to advise a potential Ebola carrier against boarding a commercial flight with some 130 passengers, for example – then so can other institutions respected for their preparedness like the Fed, the ECB, the Chinese Communist Party, or the Kremlin, not to mention less-esteemed bodies, such as OPEC.

At the Fed, Bullard may be in a minority and he won’t be a voting member of the central bank’s rate-setting committee for another two years. His Texas counterpart Richard Fisher, who is a voting member this year, told CNBC on Monday that he sees no reason to delay the end of the central bank’s bond purchases. Even so, it’s potentially unsettling to investors if some members of the leading monetary policy institution start questioning their faith.

The debate is a reminder that monetary policy doesn’t follow a prescribed and consistent line. Rather, as the Fed likes to say, it’s data-dependent. Put another way, it can be knocked off course. The same thinking can be extended to geopolitics. Many people assume, for instance, that economic considerations will keep Russian President Vladimir Putin from tipping the Ukrainian crisis into war with the West or China’s Xi Jinping from turning territorial disputes in the South China Sea into overt hostilities with Japan.

But other factors, including in both these examples eruptions of domestic dissent, could change the two leaders’ calculus quickly. That would surely result in more market volatility. However, with the odd exception that would be a symptom of bigger trouble, not a cause.


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