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Global Economic and Market Analysis

Assessing the risks and implications of currency market volatility

28th August 2014


The biggest threat to the portfolios and peace of mind of investors may not be the stretched prices of equity and bond markets bolstered by hyperactive central banks. Instead it may come from a foreign exchange market that, judging from recent policy and technical signals, may well be on the verge of exiting a historically unusual phase of low volatility.


Key Market Themes

  • The economic pack is led by the UK and US, both registering solid economic growth and consistent job gains. The frailness of the eurozone’s recovery is doing little to counter alarming high unemployment in countries struggling mightily to close the gap with the UK and US. Meanwhile, the once reinvigorated burst of Japanese growth is starting to falter.


  • The policy question before the European Central bank is how and when to step further on the monetary policy accelerator. The signals coming from the ECB point to an increasing likelihood that such a monetary easing will announced in September or, at the latest, October. In contrast, and despite well-telegraphed exit from exceptional asset purchases that will be completed in October, the U.S. Federal Reserve is coming under increasing pressure to slow down on its QE3 programme.


  • This monetary policy divergence is not accompanied by meaningful adjustments elsewhere in the economic stance. Both Europe and the US are struggling to build the needed momentum to implement the necessary structural reforms that are needed to ensure overall policy effectiveness and counter financial market excesses.Political constraints also hamper responsive fiscal policy. Meanwhile, geopolitical tensions in Europe are carrying unfavourable winds that are accentuating both economic and policy divergences.


  • These divergences have been primarily reflected in growing interest rate differentials. Nothing could exemplify this differential better than the gap between market rates on US 10-year government bonds relative to their German peer widening to almost 145 bp at the end of last week, compared with 93 bp a year ago and 108 bp at th ebegining of 2014. This huge gap should it become wider, will lead to pronounced currency moves, leading to a continued strengthening of the dollar versus the euro and , to a lesser extent, the yen- that many hedge funds are predicting to be on the verge of a technical breaks. Notwithstanding the fact that volatility in the FX market has been repressed by central banks, this extremely low volatility will be harder to maintain in light of increasing economic and policy divergences. Moreover, weker currencies are implicit and increasingly explicit targets of monetary policy in the Eurozone and Japan.


  • In this context, it will be fair to assume that the potential for technical tipping points could inevitably lead to a surprising, sharpening movements of FX. The fact that Corporate hedging activity is often pro-cyclical and that companies tend to protect themselves against unfavourable currency moves will not affect the speed of these FX movements once they have started in earnest. It is also worth noting that financial investors add to this cycle of pro-cyclicality by switching capital flow regimes, including by turning weakening currencies into funding vehicles as opposed to recipients of capital. And since many foreign stock investors do not separate the equity risk they take from its currency component, it is only a matter of time until FX instability is transmitted more broadly in the financial markets.


The Bottom Line

As the advanced countries increasingly embark on divergent economic and policy paths, and as sustained currency realignments become more explicit goals of policy aimed at ensuring that the weaker economies do not fall further behind the stronger ones, central banks will find it harder to repress FX volatility. This could well pose a challenge for the sustainability of investor




Equity Investors: Opportunities in a volatile operating environment.

July 12, 2012


  • In times of higher volatility, correlations tend to converge to one, creating opportunities to buy strong businesses at very attractive prices. These periods of indiscriminate sell-offs provide investors with rare opportunities to buy quality at an attractive price. Also, a volatile operating environment leads to displacement of weaker industry players. And that provides opportunities for these companies to outperform the market by taking market share or exercising pricing power.
  • The synchronized global economic slowdown does not undermine the fact that we are living in a multispeed world. In such a world, investors can access opportunities by taking advantage of the transition of emerging markets to consumer cultures, as they currently have underlevered consumers, companies and governments, as well as in some cases favorable demographics.
  • To address specific portfolio needs and challenges, equity investors need to find an attractive yield that has growth potential over time, especially in today’s low-rate environment. Besides dividend-paying companies, investors will need to explore companies with potential to increase earnings and even some cyclical companies. These companies can help position portfolios for income especially when a 4% dividend yield that grows over time is significantly more powerful than a 4% fixed coupon over time.
  • Dividends are not only a developed-market phenomenon, and sequestered to income strategies. Dividends and the ability to grow them are tremendously important for many strategies for what they can signal about a company’s position, management quality and so many other important factors. And the whole notion of getting that capital back is something that all good investors ought to focus on.
  • At SGE we advise our equity investors to have a plan for equity allocation and stick to it. They should not let the volatility of equities scare them into something off the plan. The long-term potential of equities to grow earnings and dividends is clearly valuable in a world of financial repression. In exchange for some volatility, equity investors can find opportunities to earn premium in terms of returns.


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The Swiss Global Economics will host a conference call to discuss highlights of the Global Economic and Capital Markets outlook on Monday,January 7, 2015.