Emerging-Market Shocks Pressure Dormant FX Volatility

Volatility in foreign exchange markets, after falling to some of the lowest levels since before the financial crisis, has nowhere to go but up as emerging economies falter, say the world’s biggest dealers.

While a measure of anticipated price swings between the dollar and euro jumped the most in three months yesterday, it’s still within a percentage point of the lowest level since the start of the financial crisis in 2007. Deutsche Bank AG, the top currency trader, and Morgan Stanley say that means volatility will keep rising.

“The market hasn’t accepted some of the risk events that are on the horizon,” Ian Stannard, the head of Europe currency strategy at Morgan Stanley in London, said in a Jan. 27 phone interview. “Foreign-exchange volatility is still at relatively low levels so there’s scope for it to move higher. China still poses the biggest spillover risk from emerging markets.”

China buys everything from Chile’s copper to South Korea’s cars, and evidence that its manufacturing industry is slowing triggered the latest bout of market turmoil. The failure of Turkey and South Africa to stem a run on their currencies by raising interest rates and Argentina’s experiment with capital controls has helped create a crisis of confidence that didn’t exist even two weeks ago.

Higher Risks

“We’re in an environment now where the emerging-market risks are higher, and that raises volatility risk in the market as a whole,” Bilal Hafeez, the London-based global head of foreign-exchange strategy at Deutsche Bank, said in a Jan. 27 phone interview. “The Fed taper is clearly in the price.”

JPMorgan Chase & Co.’s Global FX Volatility Index rose to 8.8 percent as of 12:06 p.m. in New York, from 7.86 percent Jan. 22. The firm’s emerging-markets gauge rose to a more than four-month high.

Implied three-month volatility in the euro-dollar rate, the most commonly traded currency pair, rose 0.4 percentage point yesterday to 7.15 percent, the biggest increase since Oct. 31, data compiled by Bloomberg show. The measure climbed from 6.41 percent on Jan. 15, the lowest level since October 2007. It touched 9.53 percent in February and surged to more than 25 percent at the peak of the global crisis in December 2008.

Corporate Earnings

Goldman Sachs Group Inc. is “neutral” on emerging-market currencies, though they may become attractive “in the next couple of months” if central banks keep raising rates, Thomas Stolper, a London-based strategist at the firm, said in a Jan. 29 interview.

Rising volatility has the potential to hurt corporate earnings because companies don’t have time to adjust hedges. It also may curb returns for traders who seek to profit from difference in interest rates among nations. Deutsche Bank’s G-10 FX Carry Basket Spot index fell on Jan. 24 to the lowest level since August.

After jumping in mid-2013, price swings shrank after Dec. 18, when U.S. Federal Reserve Chairman Ben S. Bernanke confirmed the central bank would start cutting its $85 billion of monthly bond purchases by $10 billion. The central bank reduced the purchases further to $65 billion on Jan. 29.

“The Fed is succeeding in introducing the tapering without shocking the markets,” Olivier Korber, a derivatives strategist at Societe Generale SA in Paris, said in a Jan. 23 interview. “Lower volatility is definitely better for companies’ foreign-exchange risks.”

China, Argentina

Certainty from the Fed is no longer enough to contain price swings in the $5.3 trillion-a-day global currency market.

A gauge of Chinese factory output confirmed yesterday that manufacturing in the world’s second-biggest economy is slowing, a week after an initial estimate triggered the biggest slump in developing-nation currencies in five years. Deadly protests from Ukraine to Thailand stoked the selloff, as Argentina’s devaluation of its peso last week dented confidence throughout Latin America.

A Bloomberg index of the 20 most-traded emerging-market exchange rates has tumbled 3 percent in 2014, extending its decline over the past year to more than 10 percent, bigger than any annual slide since 2008.

“Policy and economic news are more consistently driving currencies now, as opposed to just over a year ago it being all about the Fed,” Chirag Gandhi, who oversees $4.5 billion of fixed-income assets at the State of Wisconsin Investment Board in Madison said in a Jan. 22 phone interview.

Raising Rates

European currencies have led the slide in emerging-market exchange rates over the past week, with Poland’s zloty, Hungary’s forint and Russia’s ruble weakening about 2 percent versus the dollar.

South Africa’s rand touched a more than five-year low of 11.3909 per dollar and Turkey’s lira fell back toward a record-low of 2.39 this week after their central banks raised rates, following in the footsteps of policy makers from Brazil to India. The Ankara-based bank increased Turkey’s highest rate, the overnight lending rate, to 12 percent from 7.75 percent.

“Speculators will not be deterred by a 12 percent interest rate,” Neil Azous, the co-founder of Stamford, Connecticut-based advisory firm Rareview Macro LLC, wrote in a Jan. 29 client note. “The monthly cost of funding a short position is marginal relative to the risk-reward of making a profit of multiple percentage points in a day.”

Facing ‘Headwinds’

Dan Ammann, who became General Motors Co.’s president on Jan. 15, told a conference in Detroit the next day that the carmaker is experiencing “significant foreign-exchange headwinds.”

United Parcel Service Inc., a bellwether because it ships a variety of goods worldwide, warned in October that volatility could wipe $40 million off fourth-quarter earnings. The Atlanta-based parcel company confirmed yesterday that earnings per share matched a preliminary estimate.

“It may have been a strong assumption investors made that risk sentiment could remain supported and FX volatility would stay low while the Fed tapers, and that’s now being put to the test,” Valentin Marinov, the head of European Group of 10 currency strategy in London at Citigroup Inc., the second-largest trader, said by phone Jan. 27. “We need more indication that the economic resilience in emerging markets is still there. I wouldn’t be a seller of FX volatility at current levels.”

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