(Bloomberg) -- Investors should be prepared for more volatility as overstretched markets adapt to the end of easy central-bank money, according to the head of the International Monetary Fund’s capital-markets department.
The sharp selloff earlier this year in the stock market was a “fairly isolated” event that involved the unwinding of bets that low volatility would continue, the IMF’s Tobias Adrian said in an interview Wednesday at the fund’s headquarters in Washington. Still, markets will probably face more choppy waters ahead, he said.
“We’re probably not going to see this very low volatility that we saw last year going forward,” he said. “There might be sharp spikes in volatility going forward.”
The S&P 500 Index plunged more than 10 percent from a late January peak to early February, which was followed by a rebound. Adrian refers to the drop as the “VIX tantrum,” in reference to an index that reflects market estimates of future volatility. The index spiked in February to a three-year high.
The IMF said this week that risks to global financial stability have increased over past six months, a shift that could make the “road ahead bumpy” for markets and put growth at risk. Valuations of risky assets are “stretched, with some late-stage credit cycle dynamics emerging, reminiscent of the pre-crisis period,” the fund said in its semi-annual Global Financial Stability Report.
“This current environment of strong growth momentum and very easy financial conditions is not going to last forever,” said Adrian, who previously worked at the Federal Reserve Bank of New York.
“At some point there will be adjustments, inflation might come back, monetary policy might tighten more than anticipated, economic momentum might slow. So there are lots of headwinds that will eventually realize,” he said.
The IMF noted in its report that investors aren’t currently pricing in the risk of sharply higher inflation over the next few years, leaving markets vulnerable to an “inflation surprise.”
Adrian said markets continue to price in the assumption that low inflation will continue, meaning investors could be caught off guard if consumer prices accelerate more than expected.
“There could be a faster path of monetary policy tightening at some point,” Adrian said. “We do think inflation will come back at some point.”
The IMF is warning that prices are frothy across a variety of assets, from stocks to government and corporate bonds. It’s unusual to see inflated valuations across so many asset classes, Adrian said.
“The last time we saw that was in the runup to the financial crisis,” he said. “We see stretched valuations across asset classes and across regions of the world, from advanced countries to low-income countries, from Asia to Africa to the Americas.”
The bright side is that economies are better prepared for the next downturn than a decade ago, Adrian said. “What is different today is the banking system is much more resilient, there’s a lot more capital and a lot more liquidity,” he said. “So we’re not quite as worried as we would have been."
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