Should we expect volatility to be higher in future? Every emergency procedure leaves its scars
Volatility rose significantly at the start of the COVID crisis in March 2020. Recognizing the enormity of the problem, Central Banks globally injected large amounts of liquidity in the system. A similar scenario to the GFC when an era of quantitative easing began.
Comparing the VIX index (measure of volatility) and how it reacted in 2008 with the last 12 months, there are both similarities and differences. Central Banks intervened in both cases bringing volatility down from its peak. In 2008, volatility remained higher initially until markets accepted the power of QE. In contrast, 1 year into the pandemic, volatility is still higher than before the shock and subject to sudden spikes.
Is it here to stay? “Minsky Moments” may be here for some time. The economist H. Minsky theorized that artificial suppression of risk leads to the misallocation of risk capital through potential asset bubbles. This leaves markets fragile and subject to destabilization.
Scars take time to heal. This suggests to us that the ability of central banks to dampen volatility through extraordinary interventions is less predictable than in the past and periods of volatility may remain.
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