Last week, Bloomberg's Richard Breslow debated whether it’s the size or speed of moves that more unsettle markets. It seemed particularly pertinent as investors were struggling to make sense of the dramatic steepening of sovereign yield curves across the globe.
The answer is, it’s always the speed. And when it involves a reversal of direction, the fear factor is multiplied.
Central banks have done their utmost to make the trend your friend. No matter how distasteful or unwarranted the price levels.
By suppressing volatility and enshrining the concept of a risk “put,” modern portfolio theory has been stood on its head. It became not only possible, but advantageous, to explain away tail risk, unless it’s positive. Hedges become an expense to be reduced in search of returns.
For much too long, only bad news has triggered the reaction function. Geo-political risk is something for monetary policy- makers to worry about.
Of course risk in all its forms is under-priced. That’s been the whole idea.
But the market can’t shake the idea that there’s important tail risk from a shift in how Japan deals with its intractable problems. It’s a risk that can’t be defined away. And whether the BOJ consciously or inadvertently changes how the game is to be played.
As central banks lose their mojo, economic cycles rise from the ashes or policy-makers have to change strategy, there will have to be a major re-think of all that’s become rote in investing methodology.
The angst caused by recent curve steepening argues that the seeds of doubt about the status quo may finally be taking root. People want to buy this dip, but there’s been very little insistence that it’s time critical. Or level irrelevant.
For investors, all of this has dramatically raised the stakes for this BOJ meeting.
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