Bank of International Settlements warns of 'violent' market crash

Low levels of market volatility persist despite conflicts and crises across the world

Investors buying assets on the misguided presumption of a level of liquidity

Share prices continue to plummet as investor confidence decreases

A potentially 'violent' stock market crash could be on the horizon as financial markets become dangerously stretched, a think-tank has warned.

The Bank of International Settlements said that suspiciously low levels of volatility in the markets seen this year suggest a lack of liquidity that could trip up investors who assume they can dispense of assets when a sell-off begins.



The speech came as the FTSE 100 index suffered another day of losses, dropping 2.8 per cent and mirroring falls across Europe: Greece's stock market trading was down 9 per cent at one point today.

The beginning of the end?: The BIS has warned of a 'violent' market crash as low volatility in the markets continues despite a series of major global and political problems.

Guy Debelle of BIS said global investors were buying assets on the misguided presumption of liquidity that does not exist and that in a possible sell-off, volatility and price movements ‘will be exacerbated by the reduced capacity and inventory of market makers’.



Despite a string of potentially destabilising issues - including heightened tensions in the Middle East and Eastern Europe, uncertainty about the turning point in US monetary policy and increased concerns over China’s economy - the BIS observed that volatility in fixed income, equity and foreign exchange markets has fallen to ‘historically low levels’.

Speaking in Sydney, Debble, who is also an executive at Australia’s Reserve Bank, said: ‘While there is more forward guidance from central banks in place than in the past, investors do not have to believe it’.

He added, ‘I find it somewhat surprising that the market (in aggregate at least) is willing to accept the central banks at their word and not think so much for themselves’.

A sizeable number of investors who are currently presuming that they can exit their positions ahead of any sell-off may, according to Debelle, struggle as ‘exits tend to get jammed unexpectedly and rapidly’.

Citing the US bond crash of 1994, Debelle warned that exits in the present bonds market could be even more violent in future with ‘a fair chance that volatility will feed on itself’.

Problems with subsequent sell-offs are also compounded as interest rates remain at zero across much of the industrial world. Debelle said, ‘That is a point we haven’t started from before. There are undoubtedly positions out there which are dependent on (close to) zero funding costs. When funding costs are no longer close to zero, these positions will blow up’

A gloomy outlook: share prices have fallen in recent months as investor confidence also takes a tumble.

Debelle also referred to tightened regulation in the sector introduced in the wake of the financial crisis, adding: ‘Regulatory changes have, as intended, increased the cost of market-making, and hence shifted some liquidity risk to end investors. There have also been some strategic decisions taken by institutions and internal constraints have been imposed which have reduced capacity’.

Despite being certain that low levels of volatility will cease, Debelle could not say when or why: ‘What will cause it to end? I really don’t know, as any of the events I mentioned earlier could have been a trigger for more volatility, but clearly they weren’t’.

The combination of pricing and volatility anomalies and misplaced perceptions in certain segments of the market is, according to Debelle, a ‘dangerous combination and unlikely to be resolved smoothly’.

World growth has been running at around 3.5 per cent for the past few years and recent forecasts have it set to continue at that pace for the next year or so.

But, global debt ratios are high and emerging markets have, with varying levels of success, been drawn into the ring over the last five years or so. Debt ratios in developed economies have risen by 20 percentage points to 275 per cent of GDP since the Lehman Brothers crash.



Earlier this year, BIS warned that rock-bottom interest rates had also led to ‘worrying’ signs of unsustainable growth in property and credit markets in some countries. In an effort to alleviate this problem, the US Federal Reserve is on course to bring its bond-buying programme to an end this October and is expected to begin raising interest rates next year.

BIS’s predictions and warnings may not come as a surprise to investors, as prices in stock markets across the world continue to plummet, just as they have done over the last few months.

‘Stock markets are getting battered again,’ said Craig Erlam, market analyst at City trading firm Alpari. ‘People have been talking for such a long time about when we will get a big correction in the markets but these figures suggest that they are under way and momentum is not slowing.’

UK-based stockbroker Hargreaves Lansdown said its investor confidence index is at the lowest level for two years. The last time it was this low, the FTSE 100 stood at 5,800. Laith Khalaf, senior analyst at Hargreaves Lansdown, said: ‘Negative sentiment is rife in the market right now, and indeed if you look around the globe there is no shortage of troubles to worry about’.

Earlier this week, Chancellor George Osborne warned that ‘serious clouds’ were gathering on the horizon as the global economy reaches a critical juncture with the eurozone with the potential of a looming crisis. While noting the possible impact of the ebola crisis and ongoing conflicts in the Middle East and Ukraine, the chancellor said that the biggest risk to the UK economy at the moment is ‘the risk of the eurozone falling back into recession and into crisis’.