Macro-related volatility could surge across markets as investors evaluate the policy risks associated with the upcoming U.S. presidential elections and the increasing likelihood of a Donald Trump victory.
Alfonso Peccatiello, an Italian economist based in Amsterdam and known as @macroalf on X, issued this warning in an email to his Macro Compass clients on Monday.
“The S&P 500 realized volatility is below 10%. Credit spreads are super tight, and aside from some short-lived European political drama, markets keep marching higher,” Peccatiello said, explaining the relative state of calm of today’s market landscape.
On Monday, the SPDR S&P 500 ETF Trust SPY, which tracks the 500 largest U.S. corporations, traded near the record high of 5,655 set last Friday. Meanwhile, the CBOE Volatility Index (VIX), known as the market fear index, remained below 13, indicating very low volatility levels compared to its recent history.
However, Peccatiello warned that “macro volatility is coming back,” highlighting several reasons why investors should prepare for a turbulent market environment in the upcoming months.
Suppressed economic cycles lead to system fragility
Peccatiello assumes that suppressing economic cycles with an “artificial equilibrium” from fiscal and monetary policies will make the financial system more fragile in the long run.
He said, “We are not allowed to have a recession anymore,” stressing that prolonged periods without recessions could lead to significant systemic risks.
Peccatiello used a chart by Prof. Lee Coppock, showing the number of months the US economy spent in recession over 30-year periods since the 1870s:
- 1870-1899: 179 months
- 1900-1929: 152 months
- 1930-1959: 88 months
- 1960-1989: 59 months
- 1990-2023: 36 months
Peccatiello explained that while reduced time in recessionary conditions suggests economic stability, it also indicates the suppression of natural economic cycles, leading to more macro-related volatility.
Three Main Reasons For Reduced Recession Time
- Geopolitical Stability: Reduced systemic wars contribute to financial and economic stability.
- Shift from Gold Standard to Fiat Money: The transition from a Gold Standard to a fully elastic Fiat Money system allows for rapid expansion of fiat money creation, reducing economic volatility.
- Policymaker Intervention: Policymakers’ efforts to avoid recessions have led to a suppression of natural economic cycles, potentially resulting in decreased productivity and increased economic instability.
Peccatiello highlighted the differences between the current economic environment and the pre-2008 era. The 2005-2007 period saw excessive private sector borrowing, leading to a credit-driven money expansion and the eventual housing market collapse.
In contrast, today’s money creation is primarily driven by large government deficits.
US Elections To Lead To Higher Macro Volatility
Peccatiello identified the upcoming U.S. presidential election as a significant source of potential macro volatility. Following the presidential debate, the bond market has shown signs of increased volatility, with the Treasury yield curve steepening significantly, as longer-dated yields grew more than shorter-dated ones.
The market’s response reflects concerns about Donald Trump‘s potential economic policies, which include:
- Tough stance on immigration: Likely to increase inflationary and wage pressures.
- Heavy tariffs on China: Expected to raise import prices and reduce global trade volumes.
- Pressure on the Fed to cut rates: Risk of overheating the economy and generating further inflationary pressures.
As Trump’s odds of winning the election rise, so do the risks of inflationary or stagflationary policies, leading bond market investors to seek higher term premiums, according to the expert.
Market-prediction odds indicate that the chances of Trump winning the election have surged to over 70% following the assassination attempt in Butler, Pennsylvania.
Peccatiello cautions that “if volatility comes back in bond markets, you better watch out,” suggesting that we may currently be experiencing the proverbial calm before the storm.
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Image created using artificial intelligence via Midjourney.
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