Divergent interest rate development

The currency volatility index of Deutsche Bank, is today compared to the last 20 years almost at its low. In contrast, the equity volatility index is at about its long-term average. The economic recovery varies widely around the world and central banks are reacting in different ways to rising inflation. The resulting interest rate differentials could again increase volatility in the currency market.

Considering the global role of the U.S. dollar, interest rate policy in the U.S. is particularly relevant. The Fed has already decided to scale back its bond-buying program. A rate hike in 2022 is also possible. ECB President Christine Lagarde, on the other hand, considers an interest rate hike in the euro zone next year "very unlikely." The Bank of England has announced a rate hike in the coming months; the Norwegian central bank has already become the first central bank in Europe to raise rates. In Japan, hardly anyone expects a rate hike in the next decade, given persistent deflation.

Risks in emerging markets and commodity prices

Emerging markets in particular are vulnerable to global interest rate and currency fluctuations. When the Fed shifted from expansionary to restrictive monetary policy in 2013, a capital flight from emerging markets began. Investors who had previously moved capital out of the U.S. and into emerging markets due to low interest rates returned to the U.S. in the face of interest rate hikes. This capital flight hit South Africa, Brazil, India, Indonesia and Turkey particularly hard.

Compared to 2013, these five are better positioned today in terms of their external debt. They are taking on more debt in their own currencies rather than in U.S. dollars. Nevertheless, the private sector in particular is still massively indebted in U.S. dollars. If the dollar were to rise in value, then companies would have to raise more capital in national currency to pay off their foreign debts.

Since commodities are usually traded in U.S. dollars, currency exchange rates also play a crucial role for investors. Especially precious metals and crude oil rightly clings to the reputation of a weakening of the U.S. dollar, price gains. But even when the U.S. dollar appreciates, price losses on the commodities market are only natural, as this makes commodities more expensive for investors from outside the U.S. dollar zone.

Risks for lenders

G-20 lenders are also vulnerable to currency fluctuations as the credit default risk of their international borrowers increases. Low currency volatility in recent years has led companies to hedge less currency risk. For example, according to Fed data, Japanese insurers hedged much more against currency risk using derivatives during and after the 2008 financial crisis than they do today. If currency volatility rises again in the future, such unhedged positions are a serious risk.

While one might think that currency volatility also jumped at the start of the 2007 financial crisis and the 2020 COVID crisis. In 2007, as in 2020, leading central banks responded in unison with expansionary monetary policy. Today, by contrast, the monetary guardians are taking less coordinated action and instead making individual decisions. Investors should therefore again increasingly expect high fluctuations and have their portfolios checked for corresponding risks.

Risks of imminent interest rate increases

Volatility on the currency markets has been so low in recent years that many investors no longer even pay attention to currency risks. This could soon change in view of rising interest rates. Especially investments in emerging markets and in commodities should therefore pay attention.

Currency trading is very popular with brokers, among other things, because of the high volatility. However, those who have dabbled in currency trading because of the high level of excitement have recently been rather out of place in FX markets. In recent years, currency volatility has been low by historical standards, mainly due to low inflation and zero interest rate policies. Some currency traders have migrated to crypto markets as a result. The macro environment is changing right now; consumer prices are rising, and interest rates will also rise again soon.

inside-alternavest.article.publishedAt 17.11.2021
inside-alternavest.article.on Alternavest.com