LONDON, May 28 (Reuters) - The business cycle may not be dead, but financial markets sense this one will stretched to the limits.
Just one year after then Federal Reserve chairman Ben Bernanke unleashed a summer of global market ructions by flagging a gradual withdrawal of the Fed's extraordinary monetary stimulus, financial volatility has mysteriously evaporated yet again.
That Fed moment in May 2013 caused such a stir because it foretold a potential return to "normality" after the most spectacular financial and economic bust in a generation - an inexorable return to prior policy settings and the consequent repricing of inflated financial assets that would ensue.
'Mean reversion' - in the jargon of economics wonks - means the pendulum always swings back eventually and markets craving trends typically experience their most violent episodes at the turning points.
And for a year equities and bond yields surged and emerging markets that had sucked up all the cheap western money quaked. The Fed stayed good to its word and has been tapering its bond buying this year. The slow, steady recovery continues apace.
Yet far from seeing amplified gyrations as 2014 got into gear, markets appear to have nodded off. Long-term interest rates have swooned, equities have found an elevated groove rather a sharp reversal and emerging markets recovered smartly.
So much so that despite the myriad political risks that have surfaced this year, measures of financial volatility have cratered while indices of world stock markets rebounded to within 2 percent of the all-time high last set in November 2007 - on the eve of the 'Great Recession'.
Wall St's 'fear gauge' of implied volatility on the S&P500 has returned to lows not seen since last March and its long-term average is back to its lowest since 2007.
Treasury bond volatility is flatlining at half the peaks seen last summer, and inertia in major currency markets also pushed implied volatility in the euro/dollar exchange rate to its lowest since 2007.
In fact, on the major equity, bond and currency market gauges, volatility is now some 30 percent or more below the average of the four years leading up to the crisis in 2008.
IS IT DIFFERENT THIS TIME?
So, has the recovery run into sand and are the Fed and its global counterparts set to change course yet again? To the extent global growth is being sapped by a slowing China and the European Central Bank is still clearly in easing mode, maybe so.
And given the United States is five years into a recovery and the average post-World War Two business cycle has lasted 5 1/2 years, then a U.S. downswing seems historically plausible.
But if the U.S. and world economies are about to roll over, then why are equities still so pumped up?
Well known market bears, such as U.S. fund manager John Hussmann, argue multiples are historically way overvalued, markets overstretched and stocks ripe for a big fall.
"One can always find solace from the same Broadway kick-line of dancing clowns that reassured investors that credit was sound, subprime was contained, and stocks were still cheap in 2000 and 2007," Hussmann told clients this week.
Yet what appears to be sapping volatility - and Treasury yields that have shed 50 basis points this year - is precisely the much-lampooned argument that 'this time it's different'.
Markets have had a rethink on the speed with which spare economic capacity in the form of both unemployment and idle plant and equipment is being eroded by the pace of expansion.
And the conclusion is that the scale of the hit in 2008/2009 was such that many economists now assume it could take twice as long as normal before the business cycle hits the buffers of rising prices, wages and interest rates.
Leading that thinking is former U.S. Treasury Secretary Larry Summers, who in London on Tuesday reiterated his view of a 'secular stagnation' where influences from aging demographics to advancing technology or the paying down of debts may mean super low interest rates for far longer before full employment is hit.
And it's this idea of persistent economic slack that's invading markets after a year of Fed-related anxiety.
Easy credit, expensive bonds, slow steady growth of the underlying economy and high margins can make for an extended 'sweet spot' for equities in that environment.
Gerry Fowler, head of equity and derivatives strategy at BNP Paribas, reckons the falloff in market volatility hinges on this macro view for all the micro stock-to-stock gyrations around.
"Even fairly aggressive estimates suggest the U.S. output gap won't close until 2017 and the cycle might not end until 2018," he said. "Given that, offloading equity now in its entirety doesn't make a lot of sense in our view."
(Graphics by Vincent Flasseur. Additional reporting by Jamie McGeever and Carolyn Cohn. Editing by Larry King)