Wild West Scenes in the Foreign Exchange Market

On the foreign exchange markets, emerging countries attract attention with (at times) large exchange rate fluctuations. However, these outliers often have nothing to do with economics or politics.

The emerging countries are surpassing the developed world in many areas. They are home to over 85% of the world's population and account for nearly 60% of the global economy. However, the trade in currencies of these countries represents only a modest part of the total trade volume. Yet for the first time in 12, the 2018 largest investment banks made more money from trading currencies from emerging countries than from dollars, euros, yens and pounds. This is partly due to the (sometimes) turbulent price movements of these currencies.

The prices occasionally shoot up or down in a few minutes by percentages. Those price spikes often happen in the middle of the night, when US stock markets are closed and Asian markets are starting up. Few (larger) parties are then trading, making it difficult to find a counterparty that can supply or buy up less common currencies. At the start of 2019, the Turkish lira fell by 7% against the Japanese yen within 10 minutes. A few years ago, the South African rand plunged 9% in a similar fashion. Behind those price movements is often a computer program that automatically sells/buys when a certain price level is reached.

Japanese enter the foreign exchange market
A growing proportion of these computer-controlled orders come from Japan. The Japanese see an alternative to shares or bonds in currency trading. After all, Japan's economy is barely growing, while the yield on government bonds is negative. The country has just under 800.000 currency accounts. All too often the Japanese trade in currencies from emerging countries, where the economy is growing rapidly and interest rates are still high. Traders often use leveraged instruments, which allow them to take a large position with a small amount. That yields a nice profit. However, if a currency moves in the wrong direction, automatic selling programs (which protect traders against excessive losses) sometimes kick in.

The effects of large price shocks are often brushed off. But also in the longer term, the currencies of the emerging countries can fluctuate considerably. In that case, economic and political developments often play a major role. Since the turn of the year, the Thai bath has risen 12% against the euro, where the Brazilian real fell by more than 5%. On balance, emerging currencies are benefiting from the low dollar and growing world trade. If the United States and China bury the hatchet, 2020 could be a good year for these coins.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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