Volatility likely to reach capital markets eventually, experts say

Capital markets haven't shown much of a response to economic volatility, but that is likely to change, panelists at the SIFMA Annual Meeting in Washington, D.C., said on Tuesday.

“We're in this really weird environment of low volatility around capital markets but high volatility around expected outcomes,” said Katherine Nixon, executive vice president and chief investment officer at Northern Trust.

Nixon said a “a growing fragility” exists because of the amount of leverage available combined with low interest rates, which puts the Federal Reserve “in a bit of a conundrum.”

The nonbank sector, meanwhile, has created large amounts of credit, and it remains to be seen how that will react to economic downturns or interest rate increases, she said.

The panelists generally expressed doubt that banks will pursue nonbank lending business.

Before Basel III, lenders would build a book of business that was too large and then say, “No problem, the next guy will clean it up,” said Erika Najarian, managing director and head of US banks equity research at Bank of America Merrill Lynch.

Now, such scenarios are where the Federal Reserve's Comprehensive Capital Analysis and Review “works perfectly,” because banks can be held accountable for their incremental risk-taking, Najarian said.

Nixon said central banks, meanwhile, are starting to pull back on a “post-crisis world awash with liquidity.” That is leading to “uncharted territory” as the financial system is fragile because of debt levels, and the tools from the post-2008-crisis period might not be effective when another crisis occurs, she said.

“The next crisis is not going to look like the last crisis. It never does,” she said.

Jaret Seiberg, financial services and housing policy analyst at Cowen, said political risk could emerge as a major factor if Democrats take control of Congress or even just the House. Traditional gridlock in Washington tends to be favorable for the markets, but what is unclear is how markets would react to partisan animosity “beyond what we've seen in the past,” he said.