Volatility in Fx Markets Weekly Wrap Up 5 August 2011

This week saw some of the most volatile times in asset markets, and in turn foreign exchange, since the Global Financial Crisis a couple of years ago.

At the heart of the turbulence were continued issues in both the United States and Europe. Although the US government signed off on allowing foreign debt ceiling to increase, in order for that country to continue functioning, it came at a cost. Specifically, a debt reduction plan of approximately 2.4 trillion aimed at cutting costs was the solution to reducing the U.S’s crippling debt over the next 10 years. My commentators were arguing increases in taxes, particularly at the upper end of incomes as a first best solution. However, political pressure resulted in spending cuts rather than tax increases. The downside of this deal is that aggregate demand, and hence GDP estimates, need to be downgraded in line with reduced spending. Simply stated, if governments spend less there is less economic growth as government spending is a key determinate of aggregate demand in an economy.  This resulted in a huge sell off in asset markets which had flow on effects to foreign exchange markets.

Continued issues in Europe, principally Italy and Greece, also dominated the news during the week. It was certainly a case of bad news bad news which sent markets in the U.S, Europe, Asia and Australia spiralling.

The flow on effects to the FX market was obvious as we saw massive volatility during the week. The cross currencies featuring the USD and EURO fluctuated the most. Here is a summary of the big movements

AUD/USD down 600 PIPS
NZD/USD down 350 PIPS
USD/CAD up 300 PIPS
USD/JPY up 200 PIPS
EUR/CHF down 120 PIPS
EUR/AUD up 400 PIPS
EUR/CAD up 200 PIPS

It should not take you long to work out that there was an overall move to the USD and EUR currencies during this volatility, which is in many cases is in stark contrast to the overall trend for currencies involving these pairs. For example, the AUD/USD and NZD/USD have been in an uptrend for a considerable time and dropped dramatically last week bucking the long term trend. These sharp drop offs may indicate some overselling and we will be watching closely for some bounces in the next couple of weeks.