Investors have grown accustomed to global equity markets climbing to new highs, but last week was the first time, in a long time, that we witnessed a true return to market volatility.

Driven by rising inflation and an increase in bond yields, the VIX, a measure of market volatility, saw its biggest ever daily jump. In percentage terms, the index leapt +116% from +20.00 to +37.32; the last time we observed a significant jump in the VIX was when China devalued its currency in August 2015, this caused the Shanghai Composite to fall c.8.5% and a spike, albeit brief, in volatility. This increase in volatility remained elevated throughout the week with the VIX hitting an intra-day level of 50.30 midweek, before collapsing to low 20’s and spiking again towards the end of last week, on the back of heightened market sensitivity to macro data.

Moving over to politics, Angela Merkel and the SPD have reached agreement to form a coalition government. Whilst this is good news for Europe and a result that could foster deeper EU integration, SPD members are required to approve the deal, which may not be as simple as it first seems. The US remains in partial shutdown, although progress has been made; the Senate have announced a 2-year budget deal and an extension of the debt ceiling until 23rd March. The deal was approved by the Senate and now requires approval from the House, again, this may not seem as simple as it first seems. Immigration remains a contentious issue in the US and some members are unlikely to back the bill unless open dialogue can be held around this thorny topic. Brexit negotiations remain muddled. The next key event will be a speech from Theresa May, in which she will outline the future relationship Britain wants to have with the EU.

We have continually highlighted over the last 6 months that the market will not move higher in perpetuity and that there is likely to be a pullback at some stage. We view the current volatility in the market as ‘normal’ and remind clients that inflation and rising bond yields are typical catalysts for markets to recede. However, we view recent market moves as healthy and believe letting the air out will allow markets to consolidate their gains, before moving higher, albeit at a lower pace.

Looking out to the week ahead, the main focus will be on US inflation data, which, should this show signs of softening, will provide a support level for markets. If not, we are likely to see further market volatility as markets adjust to a more normalised environment.