Is risk appetite waning?

We look at three charts which show that the long period of calm in the financial markets may be under threat. 


Tranquillity was the defining feature of financial markets in 2017.  Equity markets were buoyant, fixed income markets began to ‘normalize’ (at least in the US), and currency volatility was subdued.  Conventional wisdom is that these ‘goldilocks’ conditions will remain in situ for 2018, before things start to go awry in 2019…however, there are some signs that this view may be a little optimistic. 


Equity Markets

Last week, US stocks suffered their largest weekly drop in two years, culminating in Friday’s 666 drop in the Dow.  This move has been mirrored in Europe this morning:


Chart I: Euro Stoxx 50


We have been here before; equity markets also sold off in 2016 (the S&P, for example, declined by 10% at one point), so it is entirely possible that we are just experiencing a pause in the market before the resumption of the upward trend.  However, as monetary conditions begin to tighten around the world, we may at last be nearing the end of one the longest bull markets in history. 



Perhaps nothing symbolizes the recent state of the markets better than bitcoin.  After starting 2017 at a price of less than $1,000, it rallied by over 1300% to end the year around the $15,000 mark.  The reasons for this incredible rally are very hard to discern (most people would struggle to even describe what a bitcoin is, let alone assign any kind of intrinsic value to one) but it is highly likely that ultra-loose monetary conditions played a role in the bitcoin bubble (and, yes, it is a bubble).


Chart II: Bitcoin

So, Bitcoin’s precipitous fall in 2018 is worth paying attention to.  Not necessarily as a systemic risk in and of itself (the total market cap of Bitcoin is large, close to half a trillion at its peak, but it is quite highly concentrated – about 1000 accounts hold about 40% of the world’s bitcoin – meaning that risk of contagion is low) but rather as a ‘canary in the coal mine’, signalling a potentially important shift in market psychology.   

Market Volatility

Ultra-low volatility across asset classes has been another feature of financial markets in recent times.  Subdued volatility is not just a symptom of current market conditions however (like Bitcoin); it is also a cause of market fragility.  Lower volatility means increased (and leveraged) speculation, as investors lose their fear, become complacent and begin building up excessive risk positions (financed with debt) which are increasingly susceptible to market corrections.  As such, the recent uptick in market volatility must be watched very closely.



Chart III: Equity Market Volatility (VIX) (Black) and FX Volatility (Deutsche Bank FX Volatility Index) (Blue):

To be clear, it is far too early to conclude that a significant change in market conditions is underway.  Our base case remains that 2018 will largely represent a continuation of benign market conditions.  However, the odds that we are entering a true correction are beginning to increase, and this would have a profound impact on currency markets, with the USD being the most likely beneficiary. 


Author: Kevin Lester










White Papers



FX Hedging:

10 Common Pitfalls


Commodity & FX Risk:

An Integrated Approach


The Corporate Use of Credit Derivatives:

Where Next?


Corporate Hedger’s Guide to Basel III


Currency Volatility – Are markets nearing an inflection point?



FX Risk


“Validus designed an innovative and practical hedging strategy to address our underlying FX risk in the context of very distinct and diverse sources of competition. We are delighted with the outcome and impressed with their on-going response to the changing business and market dynamics”.


Paul Stobbs, Managing Director, Attraction World


Private Equity


 “The Validus team understand how private equity thinks about financial risk management issues and they are rigorous in the way they help our portfolio companies to understand and mitigate their risks.”


James Markham, Partner – Portfolio Management, Graphite Capital LLP


FX and Commodity Risk


“Validus provides us with independent strategic advice relating to our long-term currency and commodity risk management program.  The people are extremely capable and collaborate very well with our finance and operations teams here at JD Irving.”


Mark Bettle, Director, J.D. Irving Ltd.


FX  Risk


 “Validus developed a tailored hedging solution to mitigate the risks from our unique combination of existing supplier agreements. The implementation and management of this rolling hedging programme with our FX service providers has been expertly and efficiently handled”.  


Mark Goldby, Finance Director, SMS Electronics Ltd.


Commodity Risk


“Validus worked with us to develop a comprehensive commodity risk management programme – their analysis was both insightful and actionable.   We particularly value their independence, and they continue to work alongside our internal team to ensure our commodity price risks are managed effectively”

Gerry Gray, Finance Director, Strix Ltd.


FX, Commodity & Interest Rate Risk


“Validus comes up with risk management solutions that are innovative and comprehensive but practical to implement, that is their strength compared to other consulting companies we have worked with in the past.  Validus provided valuable insights into how FX, interest rate and commodity risks impact our organisation, and provide actionable recommendations and solutions.”


Andrew Ayres, Finance Director, U-POL Ltd.

Recent Comments