Markets are heading into a stormy few months after the US Federal Reserve pricked the euphoria which pushed share prices to record highs, but turbulence does not mean a return to crisis, analysts say.
After elation over Japanese efforts to stimulate the economy out of two decades of deflation and stagnation sent shares soaring in May, indices in many countries tumbled about 10 percent.
Yields on government debt have also risen and emerging markets have been hit by capital outflows.
“What affected the markets was the announcement of the [US] Fed. This is what triggered the volatility,” said Olivier Garnier, chief economist at Societe Generale bank.
On June 19, US Federal Reserve Chairman Ben Bernanke signaled that the US central bank could begin winding down its asset purchase program, and stop it altogether by the middle of next year, if the US economy continues to recover.
Equities markets plunged for several days before recovering some ground last week, while the yield on 10-year US Treasury bonds shot up nearly 18 percent in one week to levels above 2.5 percent unseen for two years.
“The markets don’t really know which way to go. There is uncertainty, which has a price, volatility,” Natixis investment bank’s Rene Defossez said.
“The Fed has flipped a switch that will disturb the markets for a while,” Defossez added.
The shift in US monetary policy pushed investors to reduce their higher-risk investments. The rise in sovereign borrowing costs, if it continues and filters through to higher rates for mortgage and consumer loans, could also hit the recovery of the US economy.
However, markets have had more to worry about than just anticipating the US Fed’s actions. The slowdown in China’s economy and a credit crunch at its banks have also sparked concern among investors, as has the limping recovery in the eurozone.
Nevertheless, analysts do not expect the current volatility to degenerate into a full-blown crisis, saying the situation is still far from the chaos of the summer of 2011 when fears of a eurozone breakup swept the markets.
“This is not an end-of-the-world climate,” Amundi asset management’s Romain Boscher said.
However, stock brokerage Aurel BGC noted that “the scenario is getting more difficult for investors” as recent developments force them to review their strategies and “concentrate more on economic perspectives.”
The easy-money policies pursued by the major central banks “had hidden the bad surprises on the world economy: Chinese growth has slipped, the US economy has slowed in the second quarter, Europe is having difficulty getting out of recession,” the brokerage added.
“We are entering into a phase in which liquidity is less abundant, but which is still quite ample” due notably to stepped up stimulus by the Bank of Japan, Boscher said.
And the European Central Bank stands at the ready to help eurozone countries that run into trouble on borrowing markets.
“You have to distinguish between the start of a return to normal from a panic,” Boscher said, adding that the most violent swings were in assets considered the most risky, such as some emerging market debt and currencies.
“There would have been panic if the strategy of the Fed was seen as premature and the American economy was not sufficiently strong to afford higher market rates,” Defossez said.
A sustained rebound in share prices and a decline in bond yields cannot be excluded, according to Boscher.
Many of the investors who pulled out their money as precaution could easily pump it back in once the storm clouds lift.
Analysts at Moneycorp said that “investors really want to believe there will be no sudden shift from the stimulus of quantitative easing to the tightening of policy with higher interest rates.”
The US Fed is currently pumping US$85 billion a month into the US economy via bond purchases, a type of monetary stimulus known as quantitative easing.