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 For a post-crisis market structure that is frequently lambasted by
investors as fragmented and vulnerable to a global liquidity shock,
this is no mean feat. Global equities are down just 1 percent this
week, with little sign of worldwide systemic spillover from U.S.
technical glitches or wild swings in China.
And more broadly, despite a pick-up in volatility on bond, currency
and equity markets, major benchmark indexes have kept within a
fairly narrow trading range.
Is our imperfect system stronger than previously thought? After all,
while these shocks were clearly painful on a local level - Greek
household savings are stuck in limbo, Chinese stocks have lost 25
percent of their value in three weeks and the NYSE faces more
scrutiny - no "domino effect" took place.
One answer is that a fragmented system can actually help local
shocks stay local. Foreign ownership of Chinese equities is feeble,
Greece is a tiny slice of European corporate exposure and U.S.
stocks trade on a plethora of electronic venues that can absorb the
outage of even the world's most famous exchange.
"I hesitate to say fragmented markets are a universal good...But in
these particular circumstances, the lack of linkages has certainly
been an important contributor to relative stability," said Bill
McQuaker, co-head of multi-asset at Henderson Global Investors.
Another answer lies in shifting investor expectations of market
shocks, five years after the U.S. "flash crash" that briefly wiped
out nearly $1 trillion in market value and seven years after the
subprime crisis pushed investment bank Lehman Brothers into
bankruptcy and redrew the financial landscape.
Markets may simply have become more tolerant of technical glitches
and rapid-fire bouts of selling, some say, pointing to a system that
is not necessarily more robust or more immune to shocks but that is
able to trade around cracks when they appear.
"It's not an environment of resiliency. It's an environment of fault
tolerance," said David Weiss, senior analyst at research firm Aite
Group.
CENTRAL BANKS
The big elephant in the room when it comes to contagion risk,
however, remains the influence of central banks.
After all, one obvious reason why panic selling failed to hit this
week is because central banks and regulators took action. China's
securities regulator banned shareholders with large stakes from
selling, while the European Central Bank (ECB) reiterated its
ability to fight any contagion risk from Greece.
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While there was less need for the U.S. Federal Reserve to intervene
in the case of the NYSE outage, years of easy money may have locked
investors into complacency. Nomura's Bob Janjuah warned on Monday
that markets were "way too optimistic" about global growth and were
underestimating contagion risks.
"All global central banks are guilty of market manipulation, either
explicitly or implicitly," Deutsche Bank Managing Director Nick
Lawson told clients on Friday. "China just provides a little more
clarity about the consequences of certain actions."
The real test for post-crisis global markets has yet to come, in
other words, and may only come when central banks reverse course and
start to raise interest rates. The Bank for International
Settlements said as much last month, comparing low rates to an
elastic band being stretched to breaking point.
This in turn may topple the dominos in a bond market that has seen
liquidity dry up as banks retrench from the heavily over-the-counter
market - even as the global stock of U.S. dollar-denominated
non-bank debt has swollen to $9.5 trillion at end-2014 from $6
trillion at the end of 2010.
So even if the return of volatility to financial markets for now
remains limited to so-called "mini-tremors", there is still a fair
amount of anxiety to go round over the system's ability to withstand
bigger shocks in future.
"It's an uncomfortable time," said Lon Erickson, portfolio manager
at Thornburg Investment Management. "We have not yet had the true
test of the market."
(Additional reporting by Jamie McGeever and Sujata Rao-Coverley)
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