UBS: Recent market volatility spike is overreaction, but more volatility is expected in the future
Market volatility has been the most striking feature of the market since at least August, with heightened uncertainty over the health of the global economy driving a sharp rise in volatility. A weak US non-farm payrolls report in early August sparked concerns about a US economic slowdown, while a hawkish stance from the Bank of Japan led to a large unwinding of carry trades, causing a sell-off in US stocks. The CBOE Volatility Index broke above 65 on August 5, rising sharply from 23 the previous trading day, before falling back to 14.5.
“This spike in volatility was a huge overreaction,” said Gerry Fowler, head of European equity strategy and global derivatives strategy at UBS, attributing the rise to the historical pattern of increased volatility when nominal GDP falls, interest rates are cut and there is uncertainty in the labour market.
“So in fact, what we have seen over the past few weeks is exactly what we have been expecting, but the volatility has been an overreaction, which has consequences in the market, but so too is the current pullback seems a bit of an overreaction,” he said. “We should expect some modest increase in volatility as uncertainty increases, which is what we are seeing, but not the kind of volatility we are seeing.”
Gerry Fowler said the key driver of market volatility would be whether the US economic slowdown would lead to further job losses and whether the US would see a hard landing. He said the next monthly jobs report and initial jobless claims would be important indicators in the coming weeks.
“All the employment data will be key data points over the next few months, and in that period we will determine whether the current quite pronounced economic slowdown is the slowdown that ultimately supports the eventual rate cuts, or whether the slowdown is actually worse and leads to more job losses and a more severe economic slowdown or recession,” he said.
Looking ahead, Gerry Fowler said UBS expects market volatility to be slightly higher than current levels, with the market likely to consolidate within a range.