Goldman Warns Of Rising “Potential For Rate Shocks”

Just in case you are not sick of reading about record low volatility yet (yes, the WSJ had another piece on it this morning “Market Volatility Has Vanished Around the World“), here is Goldman’s Ian Wright pointing out that “central bank meetings didn’t jolt rate vol” (in case anyone didn’t notice), and is the latest to warn that “the potential for rate shocks has increased over longer-term horizons as more pressure builds for rates to rise.”

Yes, eventually vol will rise, or rather explode, and shocks will emerge, not just in rates, but when? And will DB’s Aleksandar Kocic be right when predicting that the longer vol remains suppressed, the more “cataclysmic” the market reaction will be.

Anyway, here’s Goldman’s Ian Wright with yet another observation (and forecast) on what central planning does to “markets.”

In the past two weeks, there were four major DM central bank meetings and statements. Among them, the BOE, BOJ and ECB did not make changes to policy rates, while the Fed hiked its policy rate by 25 bp and signalled that balance sheet normalisation is likely to start soon. Notably, downward revisions to inflation forecasts came from the Fed (for 2017) and the ECB (over the medium term). Our US economists expect the strong job market and the Fed’s dual mandate to lead to an additional hike this year and quarterly hikes in 2018 amid balance sheet normalisation starting in September. Our European economists expect tapering from the ECB in 2018, and for monetary policy to remain unchanged in the UK over the next 12 months. Our Japanese economists see the BOJ’s exit from easing as a long way off.

The market shows little concern on the path of 10-year rates. Amid the recent meetings, implied rate volatility has come down even further, reaching or nearing post-crisis lows across regions (Exhibit 1). While we can envisage more anchored rate volatility in the very near term until the next round of central bank meetings comes into focus (and given current low vol across assets), we think the potential for rate shocks has increased over longer-term horizons as more pressure builds for rates to rise.