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February 24, 2005

Market Volatility

The Economist reports. But I have one question: just who believes in the "consensus view" that "all is for the best in this best of all possible financial worlds"? I can't find anyone who does:

Economist.com: Spooked by fear of inflation, high oil prices and a revolt by Asia’s central banks, bonds, the dollar and shares all headed south, in that order. By the evening of Wednesday February 23rd, some poise had been regained. But the ease with which things went wrong—albeit just a bit—has left many wondering just how robust is the consensus view that all’s for the best in this best of all possible financial worlds.... Alan Greenspan, the chairman of the Federal Reserve, professed himself puzzled by the ‘conundrum’ presented by the flattening yield curve: the more he raised short-term rates (six times since June 2004, by 25 basis points on each occasion), the more already-low long-term rates fell. Markets don’t like it when the man who sets interest rates says he doesn’t understand them.... South Korea’s central bank, with most of its $200 billion of foreign reserves in dollars, said it planned to diversify away from the currency. Then... the price of a barrel of oil for April delivery rose back above $50. The scene was set for a sell-off, and on February 22nd the S&P 500 fell by 1.5%; the dollar lost 1.1% against the euro and the same against the yen; long-dated Treasuries continued to fall in price; oil futures rose still more and so did gold futures....

Investment analysts have two theories on volatility and market performance, and unfortunately they contradict each other. One lot believes that low volatility suggests share prices will fall, as it means that investors are too complacent.... The other group believes that low volatility suggests rising markets, as well-informed investors are rightly confident.... The reason for this week’s wobble is that America’s two greatest vulnerabilities—-its dependence on one set of foreigners to buy its bonds and on another to sell it oil—-were exposed side by side.

Posted by DeLong at February 24, 2005 10:38 AM