Currency markets: More volatility in store?

After several years of limited volatility, currency markets were shaken in 2014 — and the tension has not let up since. In the slides below, international bond trader Sean Simmons illustrates several volatility drivers and outlines what they could imply for the coming months.

Today's markets are dealing with an outbreak of currency volatility

Data: JP Morgan, via Bloomberg. Monthly observations.

Slide disclosure
Currency markets were choppy in 2014, and the volatility has bled into 2015. How did we get here? What drives this type of behavior? What are some of the ramifications?

One big driver: The profound strength of the U.S. dollar

Data: Federal Reserve Bank of St. Louis. Monthly observations.

Slide disclosure
Global economic challenges have effectively led to a currency war, with the U.S. dollar on one side and nearly everyone else on the other. Against a basket of currencies from countries around the world, the dollar has jumped by nearly 20% during the past year — its fastest climb in decades.

Another big driver: Varying economic fundamentals

Data: International Monetary Fund, as of January 2015

Uneven growth around the world is a challenge that is likely to persist for an extended time probably measured in years, not months or quarters. For 2015, U.S. output is growing at a relatively decent rate, while Japan and Europe are fighting near-deflationary conditions.

Commodities are feeling the pressure

Data: Bloomberg. Monthly observations.

Slide disclosure
A stronger dollar is pushing commodity prices down. This has put pressure on producers and can be problematic for commodity-driven exporters.

An excess of dollar-denominated debt around the world

Data: Bank for International Settlements

Slide disclosure
As borrowers around the world take on dollar-denominated debt, many have run into trouble when their currencies suddenly drop in value against the dollar. Instantly, their debt burden becomes tougher to repay.

Even the U.S. feels the pinch

Data: Bureau of Economic Analysis. Monthly observations, seasonally adjusted.

The dollar’s rise makes American products less competitive in world markets. Exports have therefore softened, entering negative territory in some cases.

Our views on probable outcomes: Three scenarios

  • Our base-case scenario is that the U.S. economy will slow down along with the rest of the world, and currency devaluation trends will take a breather. Despite this modestly hopeful near-term picture, we continue to see dollar strength over the medium term, which will likely continue to place deflationary pressure around the globe.
  • In our best-case (albeit unlikely) scenario, widespread economic growth returns, preventing central banks from chasing each other in a devaluation race.
  • Our worst-case scenario involves a managed, global single-currency regime. This rather apocalyptic scenario could be tempered, however. For instance, inflation around the world could converge at zero and economic growth could sputter, making it less necessary for countries to deliberately adjust currencies.
Launch slideshow

Charts are for illustrative purposes only.

The views expressed represent the Manager's assessment of the market environment as of May 2015, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.


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