As major central banks take policy action to combat falling inflation and support their respective economies, volatility in the currency exchange markets will likely increase.
Many central banks around the world continue to pursue exceptionally accommodative policies because a weaker currency helps boost the local economy and avoid deflation. But for one currency value to fall, another must rise. As a result, currency volatility ensues as numerous countries seek to avoid an appreciating currency that would slow their economies.
How Is This Article Useful to Practitioners?
The author points out that numerous central banks have recently caught many investors by surprise—for example, the Swiss National Bank abandoning its cap against the euro or Denmark continuing to lower interest rates further and further into negative territory. The result has been an increase in currency volatility as well as closings of some foreign exchange brokers and hedge funds. Investors should understand that countries’ continuing to abandon currency pegs will fuel additional currency volatility; each country is most likely to act in its own best interest. Looking forward, if the US dollar continues to strengthen, many Asian countries could further surprise financial markets by deviating from their currency trading bands. Market participants should be aware of these possibilities and take caution when making investment decisions.
The author provides great insight into the history of currency volatility as well as potential causes of future market disruptions. Ultimately, I would enjoy seeing further research on whether the benefits of removing a currency peg outweigh the costs of additional currency volatility.