What To Do When Stuff Happens

When markets turn volatile, it’s not time to despair. Stephen Dover, Head of Franklin Templeton Institute, offers some judicious perspectives on how to turn volatility into opportunity.

The resolve of central banks to fight inflation has caused increased volatility across capital markets—particularly in the US Treasury yield curve—owing to considerable uncertainty regarding the outlooks for inflation, growth, and a potential US recession.1 Even though the US Federal Reserve (Fed) clearly stated it does not anticipate cutting interest rates later this year, the market has a sharply different view, pricing in significant Fed easing by January 2024.

Do market participants “know” what is going to happen more than the central banks? No, quite the opposite. The uncertainty of investors is reflected in the elevated volatility of interest rates in the first half of 2023.

Adding to the “known unknowns” are the recent stresses in the banking sector, which themselves were due in large part to rapidly rising interest rates. That serves as another reminder that when central banks tighten, “stuff happens.”

This time, bitter irony compounds the misery of commercial banks. In part, they face potentially large losses on their holdings of US Treasuries (i.e., Silicon Valley Bank) because regulators were keen to see banks remain liquid and safe, and nudged them in that direction over the years.