guy debelle : volatility and market pricing speech by mr guy debelle, assistant governor ( financial markets ) of the reserve bank of australia, to citi ’ s 6th annual australian and new zealand investment conference, sydney, 14 october 2014. * * * accompanying graphs can be found at the end of the speech. thanks to michelle wright for her help. today, i will talk about a few issues around pricing in financial markets and volatility, or more precisely, the lack of volatility. volatility financial markets have been quiet, maybe too quiet, for much of this year. of course, in saying this it increases the likelihood of it ending sooner rather than later! indeed, since drafting this speech, the vix has risen to its highest level since february. if i had told you that there were heightened tensions in the middle east and eastern europe, uncertainty about the turning point in us monetary policy, a succession of strong us job numbers, uncertainty about the future direction of policy in europe and japan, as well as increased concern about the strength of the chinese economy, you would not be expecting that to make for a benign time in financial markets. but that is what we have seen for much of this year. the graph shows measures of volatility in fixed income, equity and foreign exchange markets. at some point this year, all of these have fallen to historically low levels. there has been little reaction to any of the events i have described. to the extent there has been any, it has been very short - lived. ( graph 1 ) in the past few weeks, volatility has picked up, predominantly in foreign exchange markets, which i will come back to a bit later. but even so it has not yet returned to a ‘ normal ’ level of volatility. so volatility has been low for a prolonged period of time in the face of a number of events which individually would normally be associated with high volatility, let alone all of them happening at the same time. why is this happening? a number of explanations have been advanced, but i don ’ t find any of them particularly compelling, mostly constituting, at best, only ex post rationalisations. macroeconomic outcomes for the world in aggregate have been relatively stable and that may be part of the story. world growth has been running at around 3½ per cent for the past couple of years and the latest forecasts have it continuing at that pace for the next

so things have calmed down somewhat. that said, i think most observers and policymakers tend to the view that while some recovery is welcome, the relative ‘ calm ’ seems a little eerie – perhaps fragile. certainly, these events have posed a few questions for policymakers, at least for the present speaker. among the questions being considered over recent weeks were the following : • does the “ turbulence ” simply reflect the same information that is embodied in the softer global growth forecasts that have been emerging over this period? in other words is it just a noisier version of a signal that is already being received? • or has the financial volatility been telling us there has been a significant shock, the effects of which are coming but which we can ’ t see ( yet ) in forecasts or other data? • alternatively, could the turbulence be a shock that leads to a worse global outcome – by leading to a tightening of credit conditions, loss of wealth and confidence, etc., and therefore crimping demand? • or is it just a bout of market nervousness that carries little lasting importance? bis central bankers ’ speeches as always, it is impossible to be sure, but it would not be unreasonable, i think, to draw the tentative conclusion that while these movements did reflect some underlying softening in the global outlook that was already emerging, the reaction was overdone. commodity prices are well down, but actually some prices had been declining for quite a while. iron ore, for example, peaked as long ago as february 2011. moreover, in many cases declining commodity prices reflect additional supply, which usually carries a different – positive – implication for global growth, as opposed to weaker demand. while global growth forecasts are being lowered, at this stage they see higher growth rates than in 2001, which was a relatively mild slowdown episode. of course that is just a forecast – but so far there are not any actual data that invalidate that view. given some recovery in markets of late, it seems too extreme to conclude that this event itself is developing into a significant financial shock with important additional macroeconomic significance beyond the softer global growth already understood to be in prospect. having said all that, i don ’ t think we should write the episode off as just another bout of nervousness. even if the volatility was not necessarily a reflection of fundamentals, it ’ s worth ensuring that we have extracted all the information we can from it. in addition, some quite big policy