Currency Volatility: Behind the Swings in the Foreign Exchange Market

By Jimmy Pickert, CFA, CRPS®

Jimmy Pickert, CFA, CRPS®

Jimmy Pickert, CFA, CRPS® Portfolio Manager

There has been a lot of attention focused on the strengthening of the U.S. dollar over the past year as the currency inches towards parity, or a one-to-one exchange rate, with the euro for the first time since 2002. In fact, currencies across the world have seen a marked increase in volatility recently. The Russian ruble reversed 10 years of appreciation in a matter of months, falling more than 40 percent against the dollar. The Swiss franc climbed more than 20 percent on the dollar in a matter of minutes after actions taken by its central bank last month. The Australian dollar has fallen more than 13 percent in the last 12 months, while the Canadian dollar has fallen almost 12 percent over the same period.

Two main factors are driving the uptick in volatility after what had been a relatively calm period in the forex markets. First, central bank policies across developed countries have begun to dramatically diverge. The Federal Reserve has ceased its bond buying program known as Quantitative Easing (QE) and seems likely to raise interest rates this year. At the same time, the Bank of Japan is in the midst of its own version of QE and last month the European Central Bank announced its intent to start its own program this March.

Second, the rapid and unexpected fall in the price of commodities — primarily oil — has weakened the economies of many countries that rely heavily on these commodities as a source of revenue. Central banks often combat these economic headwinds by weakening the national currency so as to boost exports. Several countries, including Russia, Canada and Australia, have already cut interest rates in an effort to weaken their currencies precisely for this purpose.

Recent currency trends have several implications for the average American. As long as the dollar continues to strengthen, expect overseas goods to become more affordable while prices at home continue to rise. If you’ve been saving for a trip overseas, now may be a good time to take it. The cash you spend will go further than it would have a year ago. When it comes to investing, placing money abroad may disappoint U.S. investors as it did in 2014, when returns were positive in local currencies but negative from the dollar’s perspective.

This isn’t to suggest that investors should avoid international investments. On the contrary, international exposure is essential to any well-diversified portfolio. Trends inevitably change, and they often do so without warning. Currency movements like the strengthening dollar create both benefits and challenges for everyone. The most important thing is to be aware of how such movements can affect your transactions and investments.

— Posted on February 19, 2015 by Jimmy Pickert, CFA, CRPS®

— Topics: Market Performance