Pill-popping financial markets are a patient who has swallowed enough central bank medicine to become numb to any shocks, perceived or real.
Shocks that previously sent markets into spasms are still being watched closely, but it is not long before they are deemed to have no lasting effect, enabling the market to continue functioning normally.
Brexit has caused barely a tremor beyond sterling, there has been no market seizure from the renminbi’s fall since the start of the year — by 3 per cent against the dollar, more than 5 per cent versus the euro — while the failed coup against Turkish president Recep Tayyip Erdogan and its repercussions left European stocks, 10-year Treasury yields and the currency market beyond the Turkish lira untroubled.
Risk-seeking might have been put on hold for the day as the market absorbed the implications of the Turkish political crisis, says Simon Derrick, chief markets strategist at BNY Mellon, “but this was hardly a market where investors were actively seeking out safe havens”.
This is a different market from the one convulsed last year by Switzerland depegging the franc (January), China moving to a flexible exchange rate policy (August) and the European Central Bank turning tail and leaving monetary policy alone (December).
“At the start of the year, if you had told me that there would be Brexit, I would have said that risk assets would probably suffer meaningfully,” says Stephen Jen, London-based hedge fund manager. “But what has actually happened is much more innocuous, with the financial markets being able to shake off these shocks.”
It would be a stretch to suggest the market has become totally shock-proof. The experiences of 2015 did little to anaesthetise the market when worries about China’s slowdown and the oil price slump turned up in January.
Still, volatility is subdued. The Chicago Board Options Exchange volatility index or “Vix”, which measures the implied volatility of S&P 500 options, is trading at the low levels it reached 12 months ago.
Given concerns about China’s double “devaluation scare” in August and January, says Mr Derrick, “this seems particularly noteworthy”, he says.
Market commentators say the source for this market sang-froid comes from the doctors administering the pills, the central banks. Since the 2008 financial crisis, policymakers and their meetings, communications and subsequent actions (or inactions) have assumed huge importance to the market.
The market is still looking for economics to affect markets, whereas I think the likely path in politics and geopolitics is for pressure to build
It is a relationship described by Paul Lambert, head of currency at Insight Investment, as one in which the market has “often been overwhelmed by the behaviour of central banks”.
At the same time, Mr Lambert adds, central bank tolerance for crisis has reached zero, to the point when any significant market shift is an invitation for central banks to step in to support the market.
“In other words, the central banking community now appears to be trying to underwrite everything, and for now the market believes them,” Mr Lambert says.
This central bank “put” may provide market stability for the time being. It also drives policymaking to illogical courses of action, such as negative interest rates, and stores up long-term problems, pushing investors into risky assets in search of yield and making equity and bond valuations unsustainably rich.
“Central banks are so afraid of people getting drenched in the rain that they have taken extraordinary measures to fight nature, to prevent rain and to prevent winters. But we know there will be long-term consequences,” says Mr Jen.
“Assets are misallocated, excessive risks are being taken, pension funds and insurance companies are under extreme stress and banks are challenged.”
By dismissing shocks, the market risks misjudging them, seeing them as isolated, political, of limited duration, or confined to the area closest to the risk — such as the UK and Turkey.
These shocks may look idiosyncratic, says Matthew Cobon, portfolio manager at Columbia Threadneedle, but a lot of them are connected.
“The market is still looking for economics to affect markets, whereas I think the likely path in politics and geopolitics is for pressure to build,” he says. “Small ripples merge into bigger themes and start to change the landscape, and these factors will start to impact market prices more meaningfully.”
Economic weakness is not the cause of market underperformance but its effect, Mr Cobon adds. That leaves the market “structurally worse at coping with big shocks” than previously.
Such is the entrenched relationship between the market and policymakers that central banks are paralysed. Imagine if central banks tried to normalise policy, says Nathan Griffiths, senior market manager at Dutch-based NN Investment Partners.
“You’d likely have a major collapse in credit markets,” he says. The market has reached the point when it is willing to misprice assets “in the hope that things would get better”.
That is a market now looking addicted to the pills being prescribed by central banks — one which may need an unpleasant dose of cold turkey to bring it back to normality.