Analysis: Currency traders shrug off Lagarde’s warning

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br Christine Lagarde

Bloomberg

IMF managing director Christine Lagarde. Photo: Bloomberg

New York - Currency traders are rejecting warnings from International Monetary Fund (IMF) managing director Christine Lagarde that volatility will increase as the US Federal Reserve pares back its unprecedented stimulus programme.

After peaking at a four-month high earlier this month, a measure of anticipated global price swings has fallen back to the lowest level since October, seven weeks before the US central bank announced a cut in its bond purchases.

Average implied volatility for the currencies of Brazil, India, Indonesia, South Africa and Turkey – which Morgan Stanley dubbed the “fragile five” last year because they were vulnerable to capital flight – has fallen to the lowest in three months. Traders are emboldened by forecasts that the US will grow at the fastest pace since 2005 this year and by the Fed’s pledge this month that it would taper stimulus in “measured steps”.

Lagarde said in an interview after the Group of 20 (G20) meeting at the weekend that increased volatility would be a “spillover” of the Fed’s actions.

“A jump in volatility starting from emerging markets is unlikely as long as the recovery in developed economies continues,” Daiwa Securities chief currency strategist Yuji Kameoka said on Monday.

“Once developed markets stabilise, global markets stabilise. And that’s a positive for emerging economies.”

While the worst winter storms to hit the US in 31 years have depressed retail sales and employment growth, economists surveyed by Bloomberg still expect it to lead the global recovery. The US will grow 2.9 percent this year, surveys suggest, compared with an average 2.1 percent across the 10 developed countries.

The JPMorgan Chase Global FX volatility index fell to 7.63 percent as of 10.10am yesterday in London, the lowest since October 28 and down from a high for this year of 8.98 percent on February 3.

Traders’ expectations for future swings in the currencies of the fragile five averaged 12.3 percent, down from more than 17 percent in August. Volatility on these currencies was at a record low 8.22 percent in May, before then-Fed chairman Ben Bernanke first mooted the idea of tapering the central bank’s quantitative-easing programme.

“A major driver of the spike in volatility was the shock factor,” Standard Chartered head of foreign-exchange research Callum Henderson said on Monday. “That has worn off, and the market has gotten used to the idea of tapering.”

Investors fled emerging market assets as the start of Fed tapering coincided with reports confirming a slowdown in China’s economy.

The gauge has rebounded 2.1 percent from its February 3 low, though most emerging currencies remain weaker for the year to date. Argentina’s peso is down 17 percent against the dollar, the biggest drop among 24 developing peers tracked by Bloomberg, after it devalued, while the rand has fallen 2 percent amid labour disputes.

“The rout in emerging markets was a temporary phenomenon,” Brown Brothers Harriman currency strategist Masashi Murata said.

Stocks rallied this month, with the Standard & Poor’s 500 index of US equities closing on Monday less than one point from its record high of 1848.38, and the global MSCI all country world index at about the highest since December 2007.

Janet Yellen, who succeeded Bernanke at the Fed this month, won the praise of her peers at the G20 meeting in Sydney for helping smooth the concerns of developing nations.

The official communiqué promised to be mindful of international repercussions of monetary policy, after countries including India and South Africa called for the Fed to consider the impact of the withdrawal of its stimulus.

Yellen pledged on February 11 to maintain her predecessor’s policies by scaling back stimulus gradually. The US central bank said on December 18 that it would trim its monthly bond purchases to $75 billion (R808bn at current rates) from $85bn, before cutting by another $10bn in January.

“The tapering that we see is a result of the significant improvement of the global economy, but particularly the US economy, and that in and of itself is positive,” Lagarde said.

“There will continue to be volatility on the markets as a result of this tapering.” – Bloomberg


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