Short, sharp shocks: Why markets should brace for more

Short, sharp shocks to markets could happen more frequently, the Bank of England said Friday, as investors are warned to pay close attention as they trade in increasingly volatile world markets.

One example of such a shock was January's surprise move by Switzerland to unpeg the franc from the euro, according to Chris Salmon, the Bank of England's executive director for markets.

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The Swiss franc's sharp jump after its peg against the euro was scrapped in January, and October's "flash crash" in U.S. Treasury yields on fears about the global economy, highlight how market volatility can suddenly rise and liquidity drop, he said.

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"Financial markets may not have been truly tested for the ability to absorb price moves or flows that persist for a prolonged period, or for a wider spill over between markets," Salmon said in a speech in London. He cautioned markets to "take heed."

Indeed, the sharp fall in the price of oil over recent months, the introduction of quantitative easing in the euro zone and expectations for a rise in U.S. interest rates as early as June have fuelled both uncertainty and volatility.

"With the dollar on the move, oil on the move, there is a lot of energy in this market, a lot of concern in this market which has created a lot of volatility," Ben Lichtenstein, president of TradersAudio, told CNBC Europe.

Fed to remove 'patient' language next week: HSBC
Fed to remove 'patient' language next week: HSBC   

The euro has tumbled to 12-year lows against a broadly resurgent dollar this week, while on Friday Brent crude oil slipped under $57 a barrel after the International Energy Agency said a global oil glut was developing.

Bill Blain, a strategist at Mint Partners in London, told CNBC that financial markets faced a whole series of volatility threats and "known un-knowns." These included next week's U.S. Federal Reserve meeting, which will be closely watched for clues on the timing of a rate rise in the world's biggest economy.

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"The Fed meeting is a known un-known because we know it's going to happen, but we don't know how much pain it's going to create," he said. "It could have all kinds of unintended consequences for stock markets. Will it cause the dollar to surge and the euro to collapse, or could it be a sell-the-fact moment?"

The Bank of England's Salmon said in his speech that the severity of recent shock events was exacerbated by structural changes in the fixed income, commodity and currency markets.

Blain added that because investors were now operating in a more complex and distorted financial system, partly the result of massive monetary stimulus by major central banks, the impact of shock events was becoming harder to foresee.

"And the unexpected consequences of a feather falling in Hong Kong causing an ice age in Europe are get harder to predict," he added.

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