Monetary Authority Chief Executive Joseph Yam reminds investors to be cautious as strong forces pulling financial markets in different directions will make the markets volatile.

In his latest Viewpoint article, Mr Yam said financial market volatility is likely to increase, adding investors who are less close to the market and take a relatively longer-term view in their investments are unlikely to benefit from such volatility.

He said the most obvious factor weighing on financial markets is the external imbalance, specifically the United States' current-account deficit.

"At over 6% of GDP, and in the absence of any consensus that the inevitable adjustment will be a benign one, this is a very strong force influencing market sentiment."

Renminbi effect

The movement of the renminbi's exchange rate has also become the focus of much market attention following the introduction of greater flexibility to the exchange-rate system last July, he added.

"Given the capital-account controls on the Mainland, a few Asian currencies - fortunately not the Hong Kong dollar - are being used as proxies in taking a possibly speculative position on the renminbi, or as alternatives to holding US dollars.

"Strong political pressures have also been fuelling such position taking, so has the urge for jurisdictions with substantial current-account surpluses to diversify their ever-increasing foreign assets."

Other factors

Meanwhile, the recent historically large surge in oil prices represents another strong force with the potential to influence international financial markets sharply through its effect on inflation and interest rates.

While the apparently buoyant global economy is providing considerable support to the stability of the global financial system, as central banks do not want to be 'behind the curve' in containing inflation or anchoring inflation expectation, and as interest rates continue to rise, there may be strong reactions in individual economic sectors, Mr Yam said.

"The possibility of sharp adjustments and associated adverse effects on consumption and the economy in general cannot be ignored."