2015 set to be year for forex volatility
The plunge in oil prices has complicated the dynamics driving the expected move upwards in US and UK interest rates and has helped trigger fears over the state of the global economy. For the forex markets that spells uncertainty, which is likely to be welcomed by traders.
Fundamentals still very much favour a USD rally – though it may be a more choppy ride from now on as traders try to digest potentially conflicting signals – one of which is coming from oil.
The more than 50% fall in oil prices has fanned concerns about deflation, potentially pushing the ECB towards quantitative easing whilst delaying interest rate rises in the US and UK. It's also raised concerns about the state of the global economy suggesting it might be weaker than previously thought.
However, the plunge in oil prices is very much down to over-supply while demand was being curbed for years by prices of around $100/bl. However, within the next six months growth surprises on the upside could emerge in consuming countries and particularly in the US with its energy intensive economy and already relatively robust growth.
Indeed, with unemployment continuing to fall at a rapid pace in the US, an increase in interest rates surely can't be that far away – low oil prices are likely to accelerate that growth. It is quite likely that at some point during Q1 or just after expectations over interest rates in the US and even the UK will once again be brought forward and they could rise more quickly than central bankers are currently suggesting they will. This too could be another source of volatility.
EUR/CHF – demonstrates what intense volatility looks like
SNB proves central banks can deliver surprises to
The other source of uncertainty is geopolitical. Islamic extremism appears to be flourishing, tensions between Russia and the West remain high and there are questions over whether China can engineer a relatively smooth transition from an export- / investment-led economy to one where the consumer is in the driving seat.
Yet another source of uncertainty are central bankers themselves. The Fed, ECB, BoE and BoJ all go to great lengths to prepare the markets for any changes in policy to try and reduce surprises, which has proven to be a difficult balancing act. Often they appear to be no better informed about the state of the economy than market participants.
Among the central banks, the one that will dish out surprises, which have burned traders – is the SNB. On Thursday it gave up trying to defend its EUR/CHF peg of 1.20, reduced interest rates from -0.25% to -0.75% while CHF briefly soared through parity.
Does this now mean CHF is now once again a safe haven currency with the SNB standing back? Also, does the SNB anticipate an eminent QE move by the ECB, which would have made defending the peg very challenging.
But the key factor that will drive volatility in forex markets this year is the turning of the US interest rate cycle, which has been muddied by concerns over the global economy and falls in the prices of many key commodity groups.
By Justin Pugsley, Markets Analyst MahiFX