Were you battered by currency volatility last week?
You’d better get used to it.
UBS currency analyst Mansoor Mohi-uddin is predicting a decade of ‘super volatility’ amongst global currencies, in the Swiss bank’s new FX mega-trends 2010-2020 note. Here’s the summary:
. . . * Before the credit crunch began foreign exchange volatility fell to record lows. The global economy experienced strong growth, inflation was tame, interest rates low and the macro-outlook seemingly stable.
* The credit crunch shattered all that in 2007, and in 2008 the financial crisis induced record currency volatility. Investor confidence recovered last year. But in 2010- 2020 exchange rates are likely still to be highly volatile . . .
And his reasoning is fairly simple.
For a start, the global recovery is ending up being highly uneven. The fortunes of developed and emerging economies are diverging, if not fully decoupling. And even in more mature economies there are significant differences. The US, for instance, is rebounding much faster than the eurozone.
That economic divergence is also feeding into monetary policy differences:
. . . the shocks of 2007-2010 have challenged central banks to find new anchors to guide monetary policy. Keeping inflation rates low is now seen as insufficient given the large build-ups of debt, leverage and current account imbalances in the run up to the credit crunch.
Moreover, there is great uncertainty about when central banks should begin tightening policy now. For example, the Reserve Bank of Australia and Norges Bank have both begun raising interest rates. Several emerging economies have also tightened monetary policy including Israel, India, Malaysia, Singapore and Brazil.
In contrast, the Fed remains committed to keeping Fed funds at ‘exceptionally low levels for a considerable period’. The BOE notes it has only paused its purchases of Gilts. The BOJ continues to buy Y1.8trn of Japanese Government Bonds a month. The ECB has just begun buying government bonds too. And the Fed has also just resumed its dollar swap lines with other central banks. Thus, the conduct of monetary policy remains very unpredictable . . .
As goes monetary policy, goes fiscal policy too:
. . . Similarly, the conduct of fiscal policy also remains highly uncertain. Since 2007 governments have expanded their budget deficits enormously to offset the weakness of their economies. But as Chart 7 shows public debt as a ratio of GDP is forecast to reach alarming levels in several G7 countries including Japan, America, Italy and the United Kingdom.
This presents policymakers with a sharp dilemma. If growth remains weak and governments decide to cut their budget deficits quickly, then investors may react negatively if that leads to recession again. On the other hand, if governments are thought to have lost control of fiscal policy and are unable to pay back their debts then investors will also react adversely.
This is clearly the case with Greece. This month Athens was forced to enter a EUR110bn three year program of borrowing from the IMF and the European Union after Greece became shut out of international bond markets. As Chart 8 overleaf shows, the rise in Greek bond yields was explosive and the fall-out for the euro has been grave . . .
Combine that monetary and fiscal policy uncertainty with more unpredictable events — like central bank currency intervention, increased regulation, or the return of trade protectionism — and you have Mohi-uddin’s recipe for inconsistencies in currencies, so to speak:
. . . The foreign exchange markets are likely to be highly volatile over the next ten years. The macro-stability enjoyed by the global economy from 2003-2007 has vanished. Instead the world economy is experiencing a highly uneven recovery that will lead to large fluctuations in currency markets in 2010-2020. In addition policymaking has become less predictable and more prone to error. Uncertainty over the direction of monetary, fiscal, exchange rate, regulatory and trade policies will keep currency markets super volatile for years . . .
That’s super-volatility to the rescue markets.
Related links:
Vix-ated - FT Alphaville
‘Gun shy markets’… – FT Alphaville
A quick guide to ECB intervention – FT Alphaville
Swiss franc intervention cost a billion a day in April – FT Alphaville