Currency Market Volatility Trends and Analysis

Currency market volatility can be a wild ride, but understanding the trends can help you navigate it with confidence. The currency market is known for its high liquidity and 24/5 trading hours, which can lead to rapid price movements.

One key trend to watch is the impact of economic indicators on currency values. According to the article, a strong GDP growth rate can boost a currency's value, while a weak GDP can lead to a decline. This is evident in the example of the US dollar's appreciation against the euro during a period of strong US economic growth.

Currency market volatility can be influenced by a range of factors, including interest rates, inflation rates, and geopolitical events. For instance, a central bank's decision to raise interest rates can attract foreign investors, causing the currency to appreciate.

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Intraday foreign exchange turnover is highly correlated with volatility, with higher turnover often leading to higher volatility over the day.

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Analysis of intraday turnover in the foreign exchange spot market reveals similar patterns to intraday volatility across a range of currency pairs, with higher turnover tending to be correlated with higher volatility.

The AUD/USD, USD/JPY, and NZD/USD have a relatively higher proportion of turnover during the Sydney trading time zone, which is reflected in a flatter profile in Graph 12.

The EUR/USD and CAD/USD, on the other hand, have a more uneven distribution of trading, with the CAD/USD experiencing a large majority of turnover in the North American trading session.

The global FX market is concentrated in a few trading hubs and major currencies, with close to 80% of all FX trading taking place in the five major financial centres.

The US dollar is on one side of around 90% of all FX trades, a share that has remained virtually unchanged for decades.

FX trading involves both spot and derivatives, with the share of spot having been on a gradual decline over the last 10 years.

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Measuring exchange rates is crucial in understanding currency market volatility. Exchange rates against the US dollar generally show higher volatility in the 1998–2001 sub-sample.

The London fix and the release of US economic data cause spikes in volatility across each of the currency pairings. This is evident in the USD/EUR, USD/JPY, CAD/USD, and NZD/USD exchange rates.

Volatility is highest during the overlap of London and New York trading. This period is characterized by intense market activity and a significant increase in trading volume.

The USD/JPY exchange rate shows a spike in volatility at around 10 am, coinciding with the opening of the Tokyo stock exchange.

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The dollar is looking strong, thanks to the U.S. economy's resilience and the Federal Reserve's lessening of easing. This has taken the dollar to new highs, and it's expected to continue its strength going forward.

The dollar's performance may be tempered by the ongoing improvement in global growth, which tends to make the dollar appreciate less. However, the dollar's positive correlation with oil could benefit it, especially if Brent prices reach $100/bbl.

J.P. Morgan Research is bearish on the euro, especially if the European Central Bank cuts interest rates sooner than the Fed. This would widen the interest rate gap between the U.S. and the Eurozone, putting downward pressure on the euro against the dollar.

The pound is also expected to be bearish, with J.P. Morgan Research forecasting GBP/USD to reach 1.22 in June 2024, before climbing to 1.25 in December. This is due to the Bank of England's potential dovish pivot and better U.K. and global growth data.

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The US dollar is looking strong, with the prospect of less easing by the Federal Reserve taking it to new highs. This shift in market narrative has taken the dollar higher, as investors are now focusing on whether the Fed will ease this year, rather than when.

The US economy has proven to be remarkably resilient, with strong inflation and labor market data driving its strength. This exceptionalism is a major factor in the dollar's performance, and it's expected to underpin its strength going forward.

However, the ongoing improvement in global growth could temper the dollar's performance, as it tends to appreciate during times of risk and vice versa. This could impede the dollar's potential rise, although the US's anti-cyclical properties may still support it.

Commodities are once again top of mind for the FX space, with the complex rising almost 7% off February lows. This could benefit the dollar, particularly if Brent prices reach $100/bbl in the coming months.

The dollar's positive correlation with oil means it tends to move in tandem with oil prices, especially during supply-driven episodes. This could support the dollar, as higher oil prices fuel inflation and pressure growth.

The US's balance of payments has undergone significant changes over the last two decades, reducing its reliance on oil imports and making it less susceptible to swings in energy prices. This structural change has reduced the dollar's sensitivity to commodity prices, making it more resilient to oil price fluctuations.

In terms of intraday volatility, the US dollar exchange rate against several major currencies shows spikes in volatility at specific times, such as the London fix and the release of US economic data. This volatility is particularly high during the overlap of London and New York trading.

The USD/JPY trend is also driven by market expectations for Fed monetary policy, rather than the Bank of Japan's actions. JPY intervention remains a near-term risk, but it's unlikely to resolve the underlying issues driving USD/JPY appreciation.

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The euro's outlook is a bit of a mixed bag. J.P. Morgan Research remains bearish on the euro, especially if the European Central Bank cuts interest rates sooner than the Fed.

The European Central Bank's (ECB) policy divergence with the Fed is putting downward pressure on the euro against the dollar. This is the first time markets have been able to price in substantively more cuts from the ECB than the Fed.

However, Eurozone PMIs have been rising in recent months, which could be supportive of euro strength. This is a positive sign, but it's not enough to change J.P. Morgan Research's EUR/USD targets, which remain at 1.05.

A stronger U.S. growth data and a stronger starting point are also contributing to the euro's bearish outlook. This means that the euro's value may not appreciate as much as some might hope.

Lower targets for the euro would require U.S. and Eurozone inflation trajectories to diverge further or for Eurozone growth momentum to be disrupted once again. This is a scenario that's still possible, but not currently expected.

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The British Pound Outlook is a topic of interest for many investors. Sterling seems somewhat trapped between a dovish Bank of England pivot and better UK and global growth data.

J.P. Morgan Research is taking a bearish stance on the pound in 2024, despite some positive signs. Recent PMI data suggests further gains ahead for the UK economy.

U.K. gilts have outperformed DM bond markets in the past month, which has not translated into sterling underperformance. This may limit the ability of sterling to underperform.

The Bank of England maintaining high-for-long rates could boost confidence and reduce the downside risk associated with the pound. This could lead to a wider confidence boost that reduces the risk of sterling underperforming.

J.P. Morgan Research forecasts GBP/USD to reach 1.22 in June 2024, before climbing to 1.25 in December.

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The US dollar has shown remarkable resilience, with strong inflation and labor market data contributing to its strength. This is likely due to the Federal Reserve's reduced easing cycle.

The dollar tends to appreciate during times of risk, which is why its performance may be tempered by the ongoing improvement in global growth. J.P. Morgan Research has raised the odds of a "high-for-long" soft landing to 55%.

Commodities are once again a key factor in the FX space, with oil prices potentially rising to $100/bbl in the coming months. This would be dollar-positive due to the dollar's anti-cyclicality and higher headline inflation.

FX Exposure Analysis is a crucial aspect of managing foreign exchange risks. It involves understanding how currency fluctuations can impact a company's balance sheet, forecasted cash flows, or specific events such as a planned acquisition.

A company with international operations must regularly conduct a data-driven analysis to understand the scope of its FX exposures. This analysis should consider how certain currency moves over the next six, 12, and even 24 months would impact the company's financials.

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A risk-based approach requires a holistic view to understand how all of a company's risks fit together. This means considering how different risks, such as currency, interest rate, and commodity risks, interact and offset each other.

For example, a U.S.-based company with significant global sales might have a total net income exposure of almost $160 million less than forecast due to individual currency risk exposures. However, these risks don't move in lockstep, so simply adding them up doesn't give a true understanding of the company's exposure and hedging requirements.

Historical correlations can help estimate the diversification benefit, which in this example reduces the risk by roughly $60 million. This means the company's exposure on a portfolio basis is estimated to be $96 million.

Understanding FX exposures is critical to making informed decisions about hedging and risk management. By analyzing these exposures, companies can limit their risk exposure and protect their financial stability.

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The inter-dealer market has seen a significant resurgence in recent years, with its share of FX trading volumes growing to over 45% in April 2022, a level not seen since the mid-2000s.

This growth is particularly notable in FX swaps, where inter-dealer activity accounts for a whopping 54% of trading volumes, as well as in spot and outright forwards, where it accounts for 40% and 34% respectively.

Higher volatility in the market has likely contributed to this increase in inter-dealer trading, as dealers seek to offset inventory imbalances and engage in risk management trades.

The inter-dealer market's resurgence is a significant development in the FX market, and one that warrants close attention from market participants and analysts alike.

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Many companies are unaware of the scope of their interest rate, foreign exchange and other risks, which can be limited through risk management planning.

Companies should learn how to limit risk exposure by understanding their goals and analyzing their currency exposures.

A well-designed FX hedging strategy may not involve a 100% hedge on each of the four currencies, as that may nullify some of the natural hedge between currency and natural gas risks.

The art and science of designing a hedging strategy is determining the minimal amount of hedging necessary to achieve a target risk level, while keeping costs down and reducing operational complexity.

Companies should not root for or against the forex hedges they put in place, but instead judge the hedging strategy on whether it kept the currency volatility within an expected, tolerable range to run the business.

Companies should regularly evaluate their FX exposures and the effects of their hedge programs, incorporating new data whenever possible in an agile manner.

Currency market volatility can be caused by a variety of factors, but the underlying issue is often a mismatch between supply and demand.

The 24-hour trading cycle, which allows markets to be open at all times, can exacerbate this issue.

High leverage, which allows traders to control large positions with relatively small amounts of capital, can also contribute to market volatility.

One example of this is the 2015 oil price crash, which saw Brent crude prices plummet from over $100 to under $30 per barrel in a matter of months.

The speed at which news and information are disseminated in the modern era can also contribute to market volatility.

In 2016, the Brexit vote in the UK led to a 10% drop in the value of the British pound against the US dollar in just a few hours.