Currency Volatility In a Tough Environment

Unless you have been living in a deep cave on the dark side of the moon then you probably already appreciate that the last year has been something of a tumultuous one. No sooner did the global community pull down its collective face mask and (more or less) confine COVID to history, than long-simmering geo-political tensions exploded into all-out war in Europe. Since then the world’s economies have been hit by soaring energy prices and some of the highest inflation in decades.

The global currency and foreign exchange (Forex) markets in particular have seen near-unprecedented levels of turbulence as even some of the world’s most powerful, and generally stable currencies have been severely tested. While this currency volatility has caused major headaches for central banks, business owners, and in some cases unsuspecting travelers, the environment has proven something of a boon for currency traders who correctly anticipated the currency forecast and generated profit by successfully hedging currencies.

In today’s post, we are going to take a closer look at exactly what has fuelled this currency volatility and the impacts of it on various spheres. We will look at some of the Dollar forecast, the GBP forecast, and the Euro forecast and touch on how FX hedging can help businesses and travelers alike to minimize their exposure to further variances.

There are a whole myriad of reasons why global currencies are experiencing so much volatility right now.  The primary driver however is widely accepted to be increasing interest rates across the world’s major economies. Following the financial crisis of 2008, interest rates remained historically low in the US, the UK, and Europe for over a decade but when post-pandemic inflation reared its head in 2022, central banks responded by increasing rates numerous times and often without much prior notice.

As well as interest rates, the currency markets have also reacted to global economic conditions (high inflation, post-pandemic unemployment, and fears of recession), trade deficits, and significant geopolitical risk factors like the Ukraine war which we will examine in more detail in the next section.

While the reasons set out above are rightfully considered to be the major contributors, it is also worth keeping in mind that another factor influencing  the performance of currency pairs is tourism. Countries that receive a large number of tourists receive an additional boost to their foreign currency reserves which in turn affects value. Whereas global tourism was dragged to a grinding halt been 2020 and 2022, it has returned with a vengeance, and destinations such as Thailand are reporting record numbers of visitors spending record amounts of cash.

As you may expect, the Ukraine War has hit many currencies very hard. When Russia launched its illegal invasion in February 2022, markets scrambled amidst fears of escalation of the war spilling into the Eurozone (both Estonia and Poland are braced for possible Russian aggression).

When Russia was thrown out of SWIFT the Rouble collapsed although it quickly staged a bit of a revival when Russian President Vladimir Putin announced that future payments for Russian oil and gas would have to be paid in Roubles. Speaking of oil and gas, the cost of energy soared during 2022 and while this has hit the Russian-dependent Eurozone especially hard, most major economies are also feeling the burden.

USD Forecast

The mighty US Dollar spent 2021 climbing where other currencies stalled and put in a strong performance throughout 2022 notching up its best year since 2015.  This is in part because the US managed to stave off many of the negative effects that Ukraine was having on global economies, but also because the FED have taken hawkish early doors action in addressing inflation. Indeed, over the course of 2022, the FED raised the interest rate on 7 occasions bringing it up from 0.25% up to 4.50%.

As for the Dollar prediction for the remainder of this year, Morgan Stanley previously cut its USD forecast in January 2023 as concerns regarding an economic downturn began to ease. However the recent collapse of the Silicon Valley bank did force the Dollar to slide downward – it remains to be seen whether the shock collapse was a mere tremor or a precursor to a major shake.

GBP Forecast

For a long time, the British Pound was regarded as one of the world’s most stable currencies although that reputation is now beating a bit of a retreat.

The already untethered GBP trend took a significant turn for the worse in the Autumn of 2022 when the short-lived and ill-fated Chancellor of the Exchequer Kwasi Kwarteng announced his shock autumn financial statement. The markets responded immediately and drove the pound down by 0.64% hitting its lowest ebb since 1985.

The Bank of England responded by raising interest rates numerous times since the disastrous mini-budget and they now sit at 4%; their highest level since the financial crisis of 2008. The Pound forecast is for the moment looking dour and while the UK may have staved off a recession, the GBP prediction is unlikely to improve until inflation (currently running at 10%) is brought under control.

EUR Forecast

Perhaps the most unexpected and unnerving performance of all global currencies this last year has been that of the Euro. The European super currency (used in 19 countries by over 330 million citizens) fell to near 1:1 parity with the Dollar in September 2022, its absolute lowest point since 2002 (the year it was launched).

While it has rallied (thanks in part to decisive action by the European central bank), ongoing concerns about the Ukraine war and fears of escalation into other parts of Europe have effectively stifled the currency’s recovery and forced it to hit something of a ceiling. Even bullish traders are bracing themselves for a lukewarm performance and the Euro prediction is unlikely to improve much until some kind of accord is reached between Russia and Ukraine and its Nato allies.

The currency markets have never been more buoyant and during 2022, the world’s forex traders reported a turnover of $72 trillion However, the foreign currency transfer market is not in quite as rude health and some money transfer providers are reporting worrying falls in turnover.

Economic uncertainty often leads to investors and savers ‘battening down the hatches’, executing fewer transactions, making few purchases, and taking less risks. This, combined with a slowing global real estate market, means that fewer companies and individuals are making international money transfers and those who are, are sending lower amounts. The impact on brokerages dealing exclusively with transfers is especially astute compared to the previous 12-month period.

While currency traders may be revelling in these uniquely tempestuous trade winds, other stakeholders are finding the certainties to be hugely problematic.

For example, import and export businesses are finding that the relative value of the goods they buy and sell is changing rapidly making profit margins very hard to gauge. Corporations with offshore functions are finding that payroll costs are fluctuating and even part-time online sellers are noticings some disruption.

Travellers are another group impacted by uncertain foreign currency markets although this can work both positively and negatively. For example, last summer many American citizens took advantage of the favourable dollar-to-euro exchange rate and took long dreamed of trips to Europe.

On the flip side though, Europeans or Brits taking holidays last autumn noted that the amount of foreign currency they got for their Euros and Pounds changed daily – as the changes were usually negative, this meant that the price of stable holiday goods such as beers and taxies became gradually ever more expensive as the trip progressed.

However, there are a number of “FX hedging” strategies that both businesses and individuals can take to protect themselves against currency volatility and shifts in foreign exchange markets.

One prominent vehicle for hedging currencies is forward contracts. A forward contract is when a buyer agrees to purchase an agreed volume of a given currency, at a fixed exchange rate by a certain date. For example, a German business could enter into a forward contract to buy $10,000 at a rate of $1 = €1.05 within the next 3 months. The advantage to the business is that it locks in the exchange rate allowing them to budget accordingly and protecting them from unfavourable movements in the Euro – Dollar exchange rate. The downside is that they would also lose out on any potential favourable change in the exchange rate.

Another effective way of hedging currencies is by opening a multi-currency account. This is simply a bank account that allows the account holder to hold a “main” balance in their native currency along with sub-accounts in foreign currencies. For example, an American traveller headed to Europe could open a Euro account, change their Dollars into Euros and hold the balance until they needed it. Again, this allows customers to “lock in” and quite literally, bank the exchange rate at a time of their choosing.

In summary, severe currency volatility is making it harder than ever to offer up a meaningful currency forecast. For example, so far during this crisis, the USD trend has remained strong and commentators have been eager to point out that it remained the world’s Uber-currency. However, recent weeks have even called the Dollar forecast into question amidst fears that another banking crisis may be in the making.

Equally, while it has at times felt easy to be pessimistic about the British Pound, better-than-expected economic performance figures suggest that the worst GBP predictions may have been overly sceptical. However,  as we already said, unless the war in Europe begins to abate then the unfortunate Euro trend and prediction look fairly solid.

With all of this uncertainty, hedging currencies and FX hedging is either by way of forward contracts or multi-currency accounts are becoming increasingly valuable for businesses and travelers looking to indemnify themselves. Anybody looking to make a foreign currency transfer anytime soon would be advised to pick their moment very carefully.