Weeks of gut-wrenching turmoil are keeping investors on the lookout for further volatility explosions, despite the uneasy calm that's recently descended on world markets.
oney managers' worst fears of 2008-style ructions ultimately proved unfounded, yet the failure of three US banks and the emergency rescue of Credit Suisse in Europe revealed signs of financial stress, sparking some of the worst turbulence in recent years. Wild swings in interest-rate expectations and rallies in haven bonds ricocheted through other asset classes as traders tried to guess where a new crisis might erupt.
The stampede into higher-quality assets has now started to reverse, Citigroup strategists said. Yet it's probably too soon to declare the all-clear. A gauge of bond volatility remains at one of the highest levels since the 2008 financial crisis, even after slipping from a recent peak.
"We expect to see notable market swings also going forward, as investors ponder where central bank rates will end up, what will it take to bring inflation back to target, what will the costs be to the economy – and yes, also who will be the next casualties of higher rates," said Jan von Gerich, chief analyst at Nordea Bank.
Ironically, it was exposure to the world's safest asset, US Treasuries, that precipitated the downfall of Silicon Valley Bank. Still, Treasuries rallied massively as panic spread, and traders speculated that the banking turmoil would force central banks to pause policy tightening and even cut interest rates. The ICE BofA MOVE index, which tracks fixed-income volatility, still suggests huge uncertainty over the path of rates.
"Volatility has come off the extreme highs that were unsustainable but mind the aftershocks," said Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence. "If we are in a higher inflation regime, don't expect anytime soon that we will go back to the bond volatility lows when rates were near zero."
In contrast to bonds, equity swings were subdued. The VIX Index, a gauge of option costs tied to the S&P 500, rose past 30 but stayed well below pandemic-time levels of above 80.
The VIX is now back under 20. For strategists at Tier1 Alpha Research, that signals "there's nothing on the horizon worth fearing." They reckon it's time to go short equity volatility.
But others such as Ilga Haubelt, head of equities for Europe at Fidelity International, say the fallout from an economic slowdown and credit tightening is yet to be felt.
"We expect more volatility in equities," Ms Haubelt told clients. "We are going to start seeing intensifying top line pressures, labour costs rising, financing costs rising and cyclical indicators showing more weakness."
A measure of future volatility in major currencies jumped as the crisis unfolded but stayed lower than levels hit late last year. It has since ebbed amid expectations the Federal Reserve will end up cutting rates later this year.
Still, strategists at Bank of America warn that currency markets remain vulnerable to a liquidity crunch in 2023 as financial conditions tighten and economic growth slows. That could see volatility ramp up again as "the lagged effect of bank-credit tightening" plays out, they added.
The string of US bank failures brought new bond sales to a standstill, while the rescue of Credit Suisse wiped out its junior bondholders. Volatility on indexes measuring credit default swaps – essentially debt insurance derivatives – rose to pandemic-time highs while yield premia on a Bloomberg index of US junk-rated corporate debt blew out to around 540 basis points, the highest since October.
With spreads lingering around 487 basis points, lowly-rated companies may have to wait a while before they venture again to bond markets.