More turbulence likely in FX market

The prospect of a new period of adjustment and volatility in the foreign exchange (FX) market has increased sharply since China’s recent move to devalue its currency, says advisory group Validus Risk Management.

Last week’s intervention by the People’s Bank of China (PBoC) is significant, says Validus’ co-chief executive Kevin Lester. It comes at a time when other major global economies, such as the US, Europe and Japan attempt to “transition back to ‘normal’ conditions, following a post-financial crisis easy money binge.”

“It is unfair to single out China as a currency manipulator in an era where quantitative easing is turning many currencies into tools with which to express and implement government policy,” he adds. “However, the explicit nature of China’s control over its financial markets is still remarkable.”

As he notes, the US dollar took a hit almost as big as that incurred by the yuan itself following the PBoC’s move, as it dropped by nearly 2.5% on a trade weighted basis. Traders immediately re-priced the probability of the Federal Reserve raising US interest rates next month, reducing it to 40% from about 55% previously.

Lester concludes that the yuan’s devaluation will not necessarily persuade the Fed to hold back from a rate hike in September. However, it does “highlight the difficulties facing any economy – notably the US and the UK – currently looking to normalise monetary policy.”


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