It's not hard to see the potential flash points on the horizon:the U.S. presidential election, Deutsche Bank AG's mounting legalcharges, the day central banks stop buying bonds. Yet when itcomes to gauging risks in the world's financial markets, these daysinvestors are flying more or less blind.

That's because the once-dependable indicators traders relied onfor decades to send out warnings are no longer up to the task. Theso-called yield curve isn't the recession predictor it once was.Swap spreads are so distorted they can't be trusted. Even thevaunted VIX—sometimes referred to as the “fear gauge”—is leadingits followers astray, strategists say.

As central banks around the world pump billions of dollarsinto the global economy every month and policy makers passregulations to safeguard against a relapse of the 2008 financialcrisis, the market's best and brightest say some warning signalsare flashing at precisely the wrong time. Now, rules to shore upthe money-market fund industry that kicked in Friday are stiflingthe predictive powers of yet another set of gauges. For investors,the big worry is they'll end up being taken by surprise when thenext crisis hits.

“I have a hard time believing what the actual informationcontent of these indicators is,” said Aaron Kohli, a fixed-incomestrategist in New York at BMO Capital Markets, one of 23 primarydealers that trade with the Federal Reserve.

Take a look at the London interbank offered rate (Libor). Therate banks charge each other for dollar loans ranging from one dayto one year, Libor has surged to levels not seen since thefinancial crisis, even as the Fed has left interest ratesunchanged this year. Rather than signaling a credit stress event,as it once might have, the spike is the result of structuralchanges.

The new money-market rules have driven about $1 trillion fromfunds that buy the short-term debt of banks and corporations intothose that invest in safer securities such as U.S. Treasury bills.As a result, banks' unsecured lending rates have soared.Three-month Libor reached 0.88 percent Wednesday after touching thehighest since 2009 last week.

“There aren't a whole lot of reasons to believe there arefunding strains in these big financial institutions,” Kohlisaid.

The contortions are also seen in Libor's spread with otherrates.

The difference between Libor and the overnight index swap rate,another measure of bank funding stress that isolates credit risk,is at the widest since 2012.

And just last month, analysts at Goldman Sachs Group Inc.reminded investors how the so-called TED spread—which tracks thedifference between Libor and the yield on similar-maturity Treasurybills—has lost its ability to foreshadow funding stress. Theyremoved it from the bank's proprietary financial conditionsindex.

“My concern is that when something comes to bite us in the butt,it's not going to be something we've traditionally looked at,”said Peter Tchir, head of macro strategy at Brean CapitalLLC. “And it's going to take a while for the markets toadjust.”

Yield Curve

Analysts are losing faith in the U.S. yield curve, a tool usedto forecast the direction of the economy, as it signals a recessionthat many see as premature.

The curve is created by tracing a line through yields on bondsof different maturities. Normally, longer-maturity debt has higheryields than short-dated securities. When that inverts, it's seen asa sign the economy is at risk of contracting. In fact, it'shappened before each of the past seven recessions.

While the curve has yet to invert, it's flattened significantly.Strategists say the shift is the product of disentanglement betweenfinancial markets and macroeconomics. The gap between yields ontwo- and 30-year Treasuries touched 1.4 percentage points on Aug.30, the lowest since 2008.

“Perceptions that a flatter curve was presaging a recession wereobviously wrong,” said Ward McCarthy, chief financial economist atJefferies LLC. “We're in one of the longest-running expansions onrecord. You have to look at the behavior of financial marketsthrough the prism of central-bank policies, or central-bank balancesheets.”

In an even more esoteric corner of the market, a proxy forcredit risk called the swap spread has been turned on its head notonce but twice in recent months. The gap between the rate oninterest-rate swaps and similar-maturity Treasury yields, anothermeasure of bank credit quality, has been negative for mostmaturities for much of the past year, as regulations made itcheaper and safer to use derivatives to hedge risk and more onerousand expensive for bond dealers to trade, hold and financegovernment debt on their balance sheets.

If that wasn't enough, near-term swap spreads have swung backabove zero this year—not because conditions are normalizing, butrather due to money-market rule changes that are increasing banks'borrowing costs in an already distorted market.

Two “of those proverbial canaries in a coal mine used to beLibor-OIS and short-term swap spreads, and they just don't work aswell these days,” said Boris Rjavinski, an interest-rate strategistat Wells Fargo Securities LLC. “With all these changes, traditionalindicators of financial stress aren't working in the ways they usedto.”

Rjavinski suggested that even for a bond guy like himself,keeping an eye on the performance of bank stocks offers a betterread on how worried the market is over risks to financialintermediaries like Deutsche Bank, which has seen its value plungein recent weeks amid investor concern about the lender'sfinancial strength.

VIX Problems

But even in equities, investors aren't sure whether thetried-and-true market signals are as reliable as they once were.Years of unconventional stimulus by central banks have flooded themarket with cash and suppressed volatility. To some analysts, therise of passive investing has added another layer of complexity tohow the stock market operates.

The CBOE Volatility index, the pulse of market fear measuringthe implied volatility of the S&P 500, is becoming more erraticbecause of the proliferation of exchange-traded products, accordingto Pravit Chintawongvanich, an equity derivatives strategist atMacro Risk Advisors. These products offer investors exposure to VIXfutures and magnify the speed and size of movements in the VIXitself.

“The big rebalance orders associated with VIX exchange-tradedproducts means they are going to exacerbate the daily move in VIXfutures, which could in turn impact the VIX,” Chintawongvanichwrote in a note to clients. “So when volatility spikes, it spikesharder, and when volatility collapses, it collapses harder.”

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.