“Higher financial market volatility is a
natural consequence, an integral part of the economy’s equilibration process...”, says Bank of Canada Governor Stephen S. Poloz.
Monetary policy will always have a significant impact on rates given that activities of the central bank to set short rates will dampen moves. The risk comes when there is a transition in the rate-setting environment. This current transition will be grater than normal. A normalization of rates will not have the central bank as the largest player in the market. An extreme view is that central banks are price manipulators especially when there focus is on purchase of supply.
If we just assume a less active central bank and rates that are determined by the equilibrium of savings and investment, volatility will increase. This increase is independent of business cycles or any new crisis. The rise in volatility when the normalization comes is almost inevitable.
While this comment was made about the Canadian asset market, it can applied as a general statement to all markets around the globe and should be conventional wisdom. The normalization of rates by the Fed, ECB, BOJ, BOE or even the Bank of China will have a clear impact asset markets. While we may not know what will be the path of asset markets, many believe that if central banks are less active in trying to control prices through intervention, there will be the potential for higher volatility.
However, a review of the actual data shows mixed evidence for this argument. Some of the biggest volatility spikes have been in the post Financial Crisis period. The period of lowest stock volatility was in 2005 and the mid-90's, the period of the Great Moderation. What seems to be clear is that spikes in volatility will match with transitions in monetary policy whether conventional or unconventional.
Monetary policy will always have a significant impact on rates given that activities of the central bank to set short rates will dampen moves. The risk comes when there is a transition in the rate-setting environment. This current transition will be grater than normal. A normalization of rates will not have the central bank as the largest player in the market. An extreme view is that central banks are price manipulators especially when there focus is on purchase of supply.
If we just assume a less active central bank and rates that are determined by the equilibrium of savings and investment, volatility will increase. This increase is independent of business cycles or any new crisis. The rise in volatility when the normalization comes is almost inevitable.
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