3 Things Driving Financial Market Volatility in 2015

Volatility, the critical ingredient investors need to trade, started to gradually creep back into financial markets late in the third quarter. That prompted idle traders worldwide to take positions once again. But is that market volatility sustainable as 2015 inches near? It depends on three market-moving factors: interest rate divergence, geopolitical events, and global growth expectations.

The U.S. Federal Reserve and the Bank of England (BoE) are the two major central banks currently sharing the lead on expected interest rate hikes. Not too long ago it was the Old Lady alone that had investors guessing as to when a rate hike would be announced. But Governor Mark Carney has turned dovish recently, influenced by global economic weakness, low inflation in the U.K., and the eurozone’s abysmal economy.

The Fed continues to confound the market as to when it will make its move. Chair Janet Yellen let it slip at her debut press conference a few months back rates could be raised six months after the end of the Fed’s bond-buying program. With the Fed’s current round of quantitative easing (QE) ending this month, the tightening cycle could begin as early as the spring of 2015. However, some Fed members have issued statements that the central bank needs to be patient and raise rates only when necessary while others are urging the central bank to start the rate hike cycle.

European, Japanese Central Banks Equally Challenged
Meanwhile, the European Central Bank (ECB) and the Bank of Japan (BoJ) are wading into unknown territory. The ECB is fighting a deflationary environment as growth proves elusive in the eurozone. If there’s to be a eurozone QE program, European leaders must agree on its necessity and that is no easy feat. Especially when the eurozone’s economic powerhouse, Germany, continues to push an austerity agenda that counters the much-needed stimulus.

The BoJ was a strong supporter of Abenomics in 2013 but this year was a different story as the central bank remained in the sidelines. An increase in stimulus is expected from the BoJ to counteract the effects of the sales tax hike Tokyo introduced last April.

In general, interest rate divergence from major economies will boost the demand for currencies from high-yielding nations. Stimulus and weaker currencies will aid the recovery of lagging economies in Europe and Japan. This of course can only happen if both camps stick to their individual policies and geopolitical or emerging market demand does not disrupt expectations as they have done in the past.

A World in Turmoil
The list of geopolitical risks continues to grow and some of the events will have a greater impact on the market than others.

From the seemingly unending military dispute between Ukraine and Russia, the Islamic State’s barbaric rampage in the Mideast, the plight of pro-democracy protestors in Hong Kong, and Catalonia’s desire to separate from Spain, to the alarming spread of the Ebola virus, there’s no shortage of event-risks for investors to bear in mind.

In terms of political upheaval within the Group of Seven, the U.K. general election next May is the most relevant to volatility as Prime Minister David Cameron’s government faces an uncertain outcome. Midterm elections in the U.S. and a general election in Canada next year are unlikely to be as stirring.

Global Growth Expectations Muted
The International Monetary Fund, the World Bank, and the Organization for Economic Cooperation and Development have all cut their growth forecasts for 2014 and 2015. Here divergence among recovering economies is clear as the U.S. and the U.K. lead the developed world with Europe and Japan at a standstill. Emerging markets continue to struggle trapped between diminishing foreign direct investment that is diverted to safe-haven assets as major central banks keep the markets on edge, and unfolding geopolitical events diminish appetites for riskier investments.

Stunted global economic growth has also reduced the demand for commodities. Base and precious metals prices have fallen as supply overshoots demand. Crude oil prices in particular have been hit hard by a sluggish Chinese economy. It remains to be seen if the Organization of the Petroleum Exporting Countries’ supply constraints will drive up the price yet again, especially after the U.S. has increased its productions due to technological advances.

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