With the U.S. Federal Reserve Board at, or near, the end of its rate hiking cycle, global financial markets are in for some intense volatility, says TD Bank Financial Group.

In a new report, TD notes that from 2002 through mid-May of this year, “global financial markets enjoyed an unprecedented, uninterrupted, universal streak of stellar returns with little volatility.” Mature international stock markets saw robust returns, “but they were dwarfed by the stratospheric ascent of equity prices in emerging markets, which shifted from an era of contagious financial crises to almost five years of similarly infectious growth.”

“Markets increasingly moved in lock step with one another early this decade as the correlation between returns in global markets and the S&P 500 increased by nearly a third. Moreover, volatility — the day-to-day fluctuation of prices in any given market — was down 10% to 30% on average over the historical swings. In other words, returns were strong, they were global, and they were steady,” it notes.

Since then however, many markets have faltered and sharp volatility has emerged. “This was first seen in emerging markets, which has led to speculation that this volatility is the result of a repricing of risk in these historically volatile markets. A second related culprit offered for volatility’s return is the incentives of investment and hedge fund managers. These managers flocked to risky EM assets when interest rates were low in developed markets. Now that interest rates are rising in the developed world, these same managers are pulling out of EM’s. Overall, these two ideas do a good job of explaining the reallocation of investments across borders, but ultimately appear to be more effect than cause,” it says.

“The crucial source of volatility is the end of one of the most stimulative global monetary cycles in history,” TD suggests. Led by ample liquidity in the U.S. and Japan, financial markets were flush with cash and global asset prices rose in response. “Now that monetary conditions have tightened, asset prices are receding,” TD says. “With future tightening uncertain, markets have become skittish, responding sharply to new information. In fact, there is a strong historical relationship between the U.S. monetary cycle and financial market volatility. More importantly, history suggests that even more financial market volatility is in store for global markets – especially EM’s – once the Fed establishes they have reached their peak.”

The global rate tightening is not yet over, TD notes, as the Bank of Japan and European Central Bank are expected to raise interest rates modestly over the next six months. It does, however, believe that the Fed has already reached its peak in this cycle. “Even if the Fed surprises us and goes once or twice more, there is little debate that we are within six months of the peak,” it notes. “This means that we should expect this volatility to remain — if not increase — at least until interest rates begin to fall, which is unlikely to come until late this year, or more likely, early next year. Financial markets may be in for a bumpy ride.”