Emerging-market foreign-exchange traders are being kept on their toes this year because trading volatility is happening at a double-digit rate.
There are several reasons for this. One reason is economic and political worry. Central banks from Europe to Japan continue their easy monetary policy and the major Group-of-Seven currencies remain muted, but emerging markets have been shaken by country-specific threats and geopolitical concerns. The outbreak of a trade war between the U.S. and China has startled investors who have turned to developing-nation assets.
Argentina obtained a $50 billion credit line from the International Monetary Fund (IMF) and its peso remains the year’s worst-performing major currency. Turkey’s lira came under pressure last week with U.S. President Donald Trump threatening to impose sanctions on the country, yet it surprised investors by keeping its benchmark interest rate unchanged. China’s yuan, which is a largely managed currency, has seen an uptick in price swings, however, this month it reached the lowest level in more than a year and traders are struggling with whether a potential trade war will prompt the nation’s central bank to allow the currency to keep sliding.
While developed currencies still dominate the market, emerging countries are starting to take the market by storm, especially in currency spot trading. This new influx in currency trading excites the banking industry, because they have struggled to profit in recent years from trading mellow currencies such as the dollar, euro and yen.
The current turbulence is also magnified by the mellowness of the market since the start of the year, according to Lisa Chua, a money manager at Man GLG in New York. When the market is used to a period of calmness, even a small unexpected trend can feel huge.
Divergence is another issue. JP Morgan launched the Foreign Exchange market (FOREX) index, which tracks the level of implied volatility in G7 and emerging market economies. The measure for emerging currencies jumped to 10.14 this month, up from 7.45 in January. In contrast, the measure for G-7 currencies dropped to 6.98 percent in July. According to NEX Group, one of the world’s largest electronic trading platforms, emerging currency trading represented 17% of all daily average spot volumes this year. Implied volatility (IV) on emerging-market currencies has surged and is close to its highest level in over a year, according to JPMorgan Chase & Co. Meanwhile, looking at similar data for developed-nation currencies remains, they are more than a percentage point below the five-year average. This month saw the widest divergence between the two measures since 2011.
Another reason is the casual monetary policy in the major economies. European Central Bank (ECB) president Mario Draghi last week restated his plan to keep the ECB’s deposit rate unchanged through the summer of 2019. This puts an anchor on volatility. There is also a steadily rising Federal Reserve policy rate, and this broad strengthening of the U.S. dollar has an impact on developing markets. Slumping currencies and fears of further losses have caused central bankers in Indonesia and India to ask the Fed to be mindful of how further tightening could affect all markets, yet the Fed raised rates anyway, and will continue to gradually do so for the foreseeable future. “While a lot of die-hard emerging market investors still want to hang in there, it feels to me that a 10-basis-point move in U.S. yields matters a lot more for EM now than it does in G-10 markets” says Kit Juckes, a London-based strategist at banking institution Societe Generale SA.
Chase Muller from One River Asset Management cautions that, although geopolitical issues haven’t yet translated into developed-market currency, that could easily change. “It seems like currencies are becoming more interesting, and the fact that recent volatility in emerging markets (EM) hasn’t spilled over to developed markets (DM) doesn’t mean it won’t at a moment’s notice.”It’s probably not the best time to take a vacation. I would feel uncomfortable being away from the desk for a while.”
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