The divergence in economic growth and unemployment has already seen the Fed and BoE ease off the accelerator while the ECB and BoJ are laggards and are viewed as having scope to ease policy further. Uncertain and diverging CB outlooks suggest 2014 will be a high vol environment for financial markets.
For the major central banks there are two distinct camps with the Fed and BoE in the more hawkish camp and at the early stages of removing accommodative policy while the ECB and BoJ are in the more dovish camp and biased toward further easing.
Even within these two camps there is divergence with:
1) the BoE seen as hiking interest rates earlier than the Fed while
2) the ECB is more likely to ease policy further than the BoJ.
Since the start of the crisis easier policy from the major central banks has been a significant factor in limiting asset market volatility. The divergence in policy outlooks should now be seen as shifting the environment from a low vol to higher vol one.
The transition is not going to be abrupt as initially CBs focus on taking their foot off the accelerator with the Fed focused on tapering QE while the BoE is likely to engage in macroprudential measures to take back support previously given to the housing market.
The real volatility will likely start when there is more certainty over the timing of actual rate hikes as opposed to tightening merely being a high probability event.
Initially GBP assets are likely to lead the charge in terms of volatility compared to USD assets. The price action in the OIS market supports this view with 1y1y GBP OIS trading sharply higher and 1y1y USD OIS trading lower than their respective 2013 highs.