The foreign exchange markets can at times see extremely volatile price action. Although there are numerous potential influences that can drive prices, there are currently three major catalysts that have likely been the primary force behind some of the significant, recent swings in currency markets.
- Risk Aversion: In recent weeks, equity markets saw an extreme resurgence of volatility. The Dow Jones Industrial Average saw its largest-recorded point decline, while the VIX also saw the largest percentage climb in history. Investors have a tendency to flock to certain currencies during such periods, while shunning others. Some of the more popular currencies in times of heightened market volatility may be the U.S. Dollar, Swiss Franc and Japanese Yen. Other currencies, such as the Aussie Dollar or the New Zealand Kiwi, may see some selling pressure as investors may potentially consider these currencies as higher risk.
- Interest Rates and Monetary Policy: Another major factor affecting currency markets currently is changing monetary policies. After holding interest rates at or near zero for a decade (while also engaging in quantitative easing programs), the U.S. has now begun the process of shrinking its balance sheet and tightening monetary policy. Higher interest rates can potentially make a currency more attractive, as yield-hungry investors may look to put capital towards currencies that can provide the best returns. Countries looking to maintain ultra-low rates or providing monetary stimulus may see their respective currencies weaken against those that have removed stimulus or are in the process of raising interest rates.
- Debt: Debt can have major effects on currency markets. Nations with high levels of debt may potentially be considered higher risk by investors, as they may carry a greater risk of default. Not only that, but nations that have been cornered by massive amounts of fiscal debt may eventually be left with no choice but to adopt a weaker currency policy. In other words, countries may look to keep the value of their currency lower as it can make debt payments relatively more affordable. This is known as currency debasement, and it can have serious effects on the value of currency. In addition, countries may have another incentive to keep the value of their currency lower: Exports can potentially be increased through a weaker currency, as lower currency values make products relatively less expensive for foreign buyers. A stronger currency, on the other hand, can have just the opposite effect.
All of the above market dynamics can have a strong impact on foreign exchange markets and are in a constant state of flux. As nations look to promote price stability and conduct monetary policy, they may raise or lower interest rates as they see fit. As countries look to gain a competitive advantage in global commerce, they may enact policies that can weigh on the value of their currency, making exports more advantageous. As global investor sentiment rises and falls; investors may seek out the perceived safety of U.S. Dollars or Japanese Yen, while avoiding currencies thought to be of higher risk.
Given the current global economic and geopolitical backdrop, currency markets could potentially see rising volatility and large price swings. The era of ultra-low interest rates appears to be over, and as sovereigns look to normalize monetary policies, numerous significant trading and investment opportunities may present themselves.
There is a high level of risk in Margined Transaction products, such as, Foreign Exchange (FX) and Metals trading which may not be suitable for all traders as it could result in the loss of the total deposit or incur a negative balance; only use risk capital. Prior to trading any products offered by ATC Brokers, please carefully consider your experience level and financial situation.