Wild swings in global currencies show volatility is alive and kicking
Dollar has been biggest casualty of White House Russia scandal, buoying the euro more than 5.5pc since mid-April, while the yuan has proved remarkably stable
Whoever said volatility had died a death?
Over the past year or so, and particularly in the last several months, much has been made of the dramatic decline in volatility in financial markets. The Vix index, a popular gauge of anticipated volatility in the benchmark S&P 500 Index, fell to a 23-year low earlier this month and currently stands at just 12 points – significantly below its long-term average of nearly 20.
Vix, commonly known as Wall Street’s “fear gauge”, shot up to 15.6 on Wednesday last week (its biggest one-day rise in 11 months
While the Vix, commonly known as Wall Street’s “fear gauge”, shot up to 15.6 on Wednesday last week (its biggest one-day rise in 11 months) as the Russia scandal dogging US President Donald Trump’s administration escalated dramatically, it quickly dropped again as investors put the political turmoil in Washington on the back burner and instead focused on the generally positive economic and corporate earnings environment.
Yet in the US$5 trillion global foreign exchange markets, volatility is surging.
Last week, the US dollar suffered its worst week since February 2016, with the dollar index, a gauge of the greenback’s performance against a basket of its peers, declining more than 2 per cent.
The euro, however, appreciated more than 2.5 per cent, buoyed by the strength of the euro-zone economy and the victory of the reform-minded Emmanuel Macron in France’s presidential election. The yen, meanwhile, strengthened nearly 2 per cent as its “safe-haven” status reasserted itself in response to the turmoil in Washington.
Yet it was Brazil’s currency that gyrated the most.
On Thursday last year, the real plunged more than 7.5 per cent against the dollar, its steepest daily decline since 1999, following reports that President Michel Temer was implicated in a high-level bribery scandal that has engulfed much of Brazil’s political and corporate elite. Yet on Friday, the real was strengthening again, up 3.5 per cent as Temer insisted he would not resign.
These sharp swings in currencies reflect the strong influence of political risk on foreign exchange markets – bond markets are desensitised because of the persistent distortions created by central banks’ ultra-loose monetary policies – and have significant implications for capital flows and macroeconomic policy. The three currencies to watch are:
A weaker dollar – the index now stands at the level it stood just prior to Trump’s election as US president – is a boon for both the S&P 500 (a depreciating greenback boosts the foreign revenues of US multinationals) and, crucially, emerging-market currencies and local bonds.
Yet “long dollar” positions are still a popular trade given the Federal Reserve’s eagerness to keep tightening monetary policy. Further dollar weakness is by no means a one-way bet.
The stars are finally aligning for the euro: the withering of the Trump trade, the last burst of quantitative easing and, crucially, the recent surge in inflows into European equity funds.
While other major currencies, including the British pound, have been volatile of late, the yuan has proved remarkably stable – the reference rate used by the central bank to manage the yuan has been stronger than expected – at a time when China’s equity and bond markets have come under strain because of nervousness about Beijing’s efforts to reduce financial leverage.
Although the recent weakness of the dollar has been supportive, a stable yuan is keeping a lid on capital outflows and limiting the fallout from the clampdown on leverage.
Volatility levels may still be subdued but in global currency markets, it is anything but dull.
Nicholas Spiro is a partner at Lauressa Advisory
