Global markets: mixed signals

Global financial markets continued to edge cautiously higher through May. Equities in the US rose overall but had a choppy month as the focus on political risks intensified. The UK’s equity market made a strong gain, to touch a record high on the FSTE 100, due primarily to the weaker GBP. In Europe, increases were more modest but nonetheless held on to some post-French election optimism. And it is to be expected that continued optimism around the Eurozone economy should be supportive.

Indeed it was the Australian equity market that fared worst over the past month, declining markedly – led lower by the banking sector. A confluence of factors drove this result, including: a weakening outlook for the Australian economy; heightened risks in the domestic property market; a credit downgrade for smaller non-government guaranteed banks; and the introduction of a 6bp ‘bank tax’ in the federal budget. Lower commodity prices also weighed on resources stocks.

What is notable in global equity markets is the divergence of measured uncertainty and implied market volatility. The former is near historical highs and the latter near pre-financial crisis lows (despite a brief spike in May due to US political uncertainty that has since rapidly retraced). Historically, the relationship between the two has been relatively strong and at least has had some degree, and often a high degree, of correlation. Since around 2015 this has broken down completely. The low level of volatility is not just characteristic of equity markets; levels are low in bond and exchange rate markets also. And it is being reflected in very narrow spreads in investment grade credit that reflect, in part, a low level of perceived risk.

Global: measured policy uncertainty and financial market volatility
Material policy uncertainty is not being reflected in markets


Source: IFM Investors, Bloomberg,

This divergence likely has no single explanation. In terms of the bigger picture it may reflect the difficulty markets are having trading a more upbeat global economic outlook that remains beset by still simmering geopolitical tensions and political uncertainty. The former being supported by still accommodative monetary policy setting of major central banks. Also, market specific factors such as the flow of funds from active to passive investment may be having an influence.

Bond markets have continued to rally globally. US ten-year bond yields have fallen approximately 25bp since March and are at around 2.1%. Australian government bond yields have likewise fallen by around 60bp to 2.4%, after briefly looking to breach 3% back in February. However, what is more notable is the narrowing of the spread between the two, which has come in to as little as 16bp over recent weeks. This has not been seen since early 2001 and reflects the market’s expectation that while the US economy is performing relatively well, the outlook for the Australian economy has deteriorated.