Foreign exchange markets normalise

Some people believe that the end of the recession is nigh further to some recent gains on the foreign exchange currency markets and it is true to say that the market has generally become less risk-averse over the last few months


Foreign Exchange is one of the biggest financial markets. Chris Towner, Director of FX Advisory at HiFx, says it’s currently worth at least $2trn a day with the US dollar being involved in 86 percent of the daily trades. Survival for the dollar is very important, even though it has remained very volatile, lacking liquidity over the last two years.

It has been particularly so over the last 12 months. Yet market normalisation has begun to take hold. “Since the beginning of 2009 we have seen some stabilisation, and therefore some normalisation has come back into the markets due to government and central bank support”, Towner says. Forex has remained one of the most liquid markets, less volatile than futures and commodities.

“In many markets volatility causes reduced liquidity, but with Forex, because the markets were so deep and liquid, the increased volatility has boosted the appeal of the trading currencies”, says Adam Solomon, Head of Trading at TORfx. They are seen as an asset class, like an equity market fund. Uplift in world trade has helped to increase the market’s momentum too.

Liquidity has improved over the last few months, explains Solomon. He says that, while we are seeing a degree of stabilisation, “there are still a lot of unanswered questions, and we won’t see a recovery until late in 2010”. The renewed momentum is a return to some growth, but he asks whether the global economy and the markets will grow in the way that the IMF has predicted.

Mark O’Sullivan, Director of Dealing at Currencies Direct says that the pound is weak because quantitative easing is being used by the banks in the UK to shore up their balance sheets rather than to free up lending to consumers. “The euro is doing better, due to some sentimental surveys, but you will see higher unemployment in the eurozone by the end of the year”, he adds. He feels that the positive sentiments expressed in countries like Germany and France are not necessarily backed up by real economic data. Yet the economic stimulus that’s emanating from the US is said to be working, but its economy remains in a bad shape. Growth could wither once these packages dry up.

Last year the dollar and the yen were the ‘safe haven’ currencies. “The value of the yen against sterling in the summer of 2007 stood at 250 yen to the pound”, says Towner who adds that “in January 2009 it fell to 120 yen to the pound”. For an export market like Japan a strong currency hasn’t necessarily been a blessing. It has damaged its exports. At the other end of the spectrum is the weak pound, which is now more competitive. In spite of its weakness, the new appetite for risk-taking has strengthened it. Solomon feels that the UK Q3 09 will see the same growth that Germany and France have had in 2009’s second quarter.

Investors are nevertheless very concerned about the UK’s rising budget deficit, which is only sustainable if the international community is willing to carry it. “It’s getting worse and worse”, says O’Sullivan, “and people may want to stop buying UK debt.

The trouble is that we could see a run on the pound if buyers of government gilts and bonds dry up, and investors are very worried about whether the UK can service its own debt. The US is also at risk; it has only one key buyer of US Treasury bonds: China, which is protected from the financial markets’ movements and from speculators. The value and performance of the renminbi is tightly controlled by the Chinese government. So it’s a less risky prospect.

O’Sullivan believes that a resilient euro might represent a safe umbrella for many of the satellite countries that sit around the eurozone. Countries like Estonia and Iceland, for example, have had “heavily devalued currencies as they have been classic cases of overleveraged economies; they collapsed as the global sell-off gained pace.” Although he believes that the euro is a flawed currency, in spite of citing Ireland as being protected by the euro, he feels that its comparative hardiness could provoke a thought to fast-track them into it. “Going forward more countries may seek the safe umbrella that a hard euro can bring”, he comments. The euro has been performing fairly well, yet most of the eurozone countries are still struggling.

Over the next few months most of the focus will be on the US dollar. It could become stronger if the equity markets become nervous again and begin to buy. As the world’s reserve currency, it represents a safer bet than the higher yielding currencies like the Australian and New Zealand dollars. They would lose value and favour if the situation reverts to the way things were. Sustainable positive momentum depends on whether or not the stock markets continue to rally (as they correlate with each other), and the monetary policies of each government and central bank.