What's Powering Those Big Swings In Currency Markets

Remember when superinvestor George Soros took a swipe at the pound sterling? Well, if the analysis of Rhonda Staskow, a senior foreign exchange analyst at Technical Data in Sydney, Australia, is correct, more currencies could get knifed in exchange-rate swings that have little to do with economic fundamentals. The reason, she says, is that as mutual and pension funds increasingly go overseas looking for new investments, they are also becoming major players in the currency markets as they hedge their investments against currency shifts.

Certainly, the flow of money into overseas markets has been phenomenal. Already, says Staskow, about $170 billion of investment went outside home markets, and investments in emerging markets alone--the Brazils and Singapores of the world--could amount to $400 billion to $450 billion in coming years.

"This escalating capital flow has numerous impacts on forex markets," warns Staskow. First, a small number of players control a large amount of the money flowing into the currency markets. And the cash pouring into emerging markets means "exotic currencies" are the fastest-growing sector of the exchange markets.

Moreover, Staskow says, fund managers are relying on computer models that primarily look at a currency's past trend to forecast future direction. "The models are contributing to sharp and exaggerated moves in the forex markets," Staskow points out. And these models also mean that such economic fundamentals as interest-rate differences and inflation potential are less important in determining currency values.

For individual firms, depending on trend models can backfire big time. Gerry Davies, regional director of foreign exchange in Technical Data's Boston office, says that some funds seem to have taken heavy losses in currency trading in recent quarters. And for the economy as a whole, as more money goes into global funds, these funds "will have an increasing control on foreign currency direction," cautions Staskow.