Navigating  the macroeconomic currency risks going into the impending recession will be tough and I thought I would briefly comment on various currency regimes.  Currency risk is all-encompassing, and no asset class will escape. Right now we have a seemingly longer-term trend of a strengthening US Dollar, and until the current dynamic reverses the US Dollar is king:

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The 5-year US Dollar Index (DXY) chart, taken from http://www.marketwatch.com

Below is a list of various currency regimes. There are some serious risks looming on the horizon globally, which explains why, despite the objective lack of US economic strength, the US Dollar is rising.

Free-Floating Exchange Regime:

  • Australian Dollar (AUD)  (Unsure,  but exposed to commodity risk)
  • Canadian Dollar (CAD)  (Unsure, but exposured to commodity risk)
  • Chilean Peso (CLP) (Unsure but exposed to commodity risk)
  • Japanese Yen (JPY) (Upside potential, historical safe-haven)
  • Mexican Peso (MXN) (Downside potential, exposure to commodity risk)
  • Norwegian Krone (NOK) (Unsure, has exposure to commodities but also a haven)
  • Polish Zloty (PLN) (Unsure. Does have some commodity risk.)
  • Swedish Krona (SEK) (Unsure. Potential for civil unrest and political instability. Tax-hikes. Eurozone exposure.)
  • Great British Pound (GBP) (Downside potential. Tax hike, Eurozone exposure, reversing capital flows.)

Currency Union:

  • Euro (EUR) (Massive downside potential. Poorly designed currency union woes, instability, tax-risk.)
  • United States Dollar (USD) (Significant upside potential. See above.)

Emerging Markets:

  • Brazilian Real (BLR) (Downside potential. Capital Outflows. Debt exposure. Commodity risk)
  • Indian Rupee (INR) (Downside potential most likely.Capital Outflows.)
  • Chinese Yuan (CNY) (Downside potential. Debt. Capital outflows.)
  • Turkish Lira (TRY) (Downside potential. Capital outflows. Unrest.)
  • Russian Ruble (RUB) (Downside potential. Commodity risk. Capital outflows.)
  • South-African Rand (ZAR) (Downside potential. Commodity risk. Capital outflows.)

Some of the emerging markets already have highish levels of inflation, and some countries have hyperinflation.

Of course it should be remembered that any exchange rate change is a function of the relative velocities of the currencies, the rate of change of the numerator and denominator, as it were.  If this current US Dollar trend has legs,  it could continue for three or four more years,  either way we’re in for a wild ride.

The pegged currencies are really the point of interest though, with the increasing global volatility USD pegs are liable to break under the strain of the strengthening US Dollar. Many of the Middle Eastern currencies are heading into a financial tailspin, between the declining oil revenues (and hence tax revenues), increased currency volatility they are liable to expend their reserves quickly, leading to broken pegs and rapid overnight devaluation.

On the other hand the Swiss Franc and Danish Krone face the reverse problem. As capital flows accelerate out of the Eurozone region across their borders, they will find it increasingly hard to suppress their currencies.  This is liable to cause their pegs to break, but cause rapid overnight currency appreciation.

 

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