Volatility in Global Forex Markets

In the converging global economy, volatility has spread its tentacles beyond the equity markets to the Forex markets. Sophisticated forex market investors stumbled upon the fact of global volatility that got re-linked to various global factors like cross-country fund flows, exim trades, inflation rates, interest rates, industrial production growth rates and other socio-geographic factors that bear down forex co-movements.

Initially, the forex rate volatility was better contained within the G-3 economies-US, Japan and Germany, but later extended to G-10 countries whose currencies are traded most in the international exchanges. Exchange rate volatility not only affects the profit-seeking behaviors of currency traders, it also bows down on the productivity and profit margins of manufacturing enterprises that depend on export revenues. The macro-economic effects thus have far outreached in order to call in for monetary policy objectives from the regulators to extend support to those affected, in terms of export sops and duty cuts.











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It has been implicated that a sound domestic macroeconomic and monetary policy could diminish exchange rate volatility. However, market factors and capital flow dynamics drive exchange rate movements that may not be compromised in certain situations. Some of the recent forex misalignments are due to increased capital flow dynamics into the emerging markets and out of the developed markets, and fund flow thus triggers some factors of dynamic forex movements. $/¥ and $/€ have caught the glimpse of investors who foresee major gains in future spot prices and by also formulating the famous ‘carry trade’, where one borrow cheap (Japan) and invest in higher dollar ($) yielding assets.

The above chart depicts the forex movements of six countries tracking for a period of six months, from August 2007 till December end. Many questions remain unanswered and have become topics of great interest as to whether continued depreciation, as that happened in the case during the Asian Financial crisis 1997 leads to evolution of financial crisis, effect of exchange rate volatility on the economy, or does economic shocks always leads to a recession?

Sandy Chatterjee, Analyst
Right Horizons Research Desk