Why Investors Are Facing Even More Market Instability

Frequent flyers are accustomed to turbulence on some flights. Indeed, many expect it. Despite such anticipation, however, the turbulence can once in a while create significant anxiety among even the most seasoned travelers.

This is what happened in markets last week. The “expected” turbulence, related in large part to three continuing paradigm shifts, was turbocharged by two less-anticipated factors, whose duration will play an important role in determining the orderly functioning of markets.

Most economists, investors and traders have by now largely internalized that the global economy and financial markets are navigating three regime changes:

  • Predictable injections of central bank liquidity and floored interest rates have been replaced by a generalized global tightening of monetary policy.
  • Economic growth is slowing significantly as the three most systemically important regions of the global economy lose momentum at the same time.
  • The nature of globalization is shifting from the presumption of ever closer economic and financial integration to greater fragmentation in part because of persistent geopolitical tensions.

Both by themselves and collectively, these three changes involve increased economic and financial volatility. In terms of the distribution of possible economic and financial outcomes, the baseline is becoming less attractive and more uncertain, and the possibility of highly negative scenarios become greater.