The effect of reduced macroeconomic and cross-asset volatility since the start of 2023 was made evident by the first quarter currency impact report from cloud treasury solutions firm Kyriba, published in July.
According to data from the earnings calls of 1,200 publicly-traded North American and European companies, the collective quantified negative impact of currency movements was $22.5 billion, a 25.5% decrease from the fourth quarter of 2022.
The drop in volatility was helped by a resynchronization of monetary policy between the major central banks as market expectations shifted towards anticipating the peak of the US Federal Reserve’s tightening cycle and how its peers would move to catch up.
The market was also concerned that the Fed’s aggressive approach would tip the US economy into recession, a view amplified by the US regional banking crisis, observes Nick Kennedy, who manages FX strategy at Lloyds Banking Group.
“So far that view has proven excessively gloomy but it helped contain dollar moves and broader currency volatility earlier in the year,” he says.
Disinflationary trends and resilient growth in many parts of the world saw a number of central banks slow their tightening cycles earlier in 2023.
“Much of this disinflation has been down to easing supply chain issues and softening energy prices, meaning demand has been able to stay resilient even in the face of tighter policy, which has allowed broader risk appetite to stay firm,” says Dominic Bunning, head of European FX research at HSBC.
Hawkish response
Currency gains for the European corporates covered in the Kyriba report have fallen sharply since late last year, from $16.8 billion in the third quarter of 2022 to just $600 million in the first three months of 2023.
The euro strengthening against the dollar was a key factor in this drop as the European Central Bank (ECB) turned decisively hawkish in response to rising inflationary pressures, but there was also more settled range-bound trading in a number of other markets.
Kennedy points to sterling’s recovery after the extreme volatility that accompanied the short-lived reign of Liz Truss as prime minister as an example of the latter.
Developments have impacted the competitiveness of European car manufacturers and other essential exporters
Alex Kuptsikevich, FxPro
European companies have also lost out because of lower demand for the region’s goods from Russia and China, the collapse of the yen (which has fallen to its lowest level against the euro since 2008), and the weakening of the yuan.
“These developments have impacted the competitiveness of European car manufacturers and other essential exporters,” says Alex Kuptsikevich, senior analyst at FxPro.
Both the euro and the pound fell off the list of the five most volatile major currencies, after featuring in all three previous quarters.
“The pound has started to pick up in volatility in recent weeks, but throughout most of 2023 it has been one of the strongest and least volatile of the major currencies,” says Pete Mulmat, CEO of IG US. “This could be attributed to the Bank of England raising rates close to the Federal Reserve and relatively higher than central banks in the euro area, Australia and Japan.”
While suggesting the Bank of England has under-delivered a little in terms of rate hikes, Kennedy at Lloyds reckons this has probably driven the situation to a point where the ultimate terminal rate will have to be higher than it would otherwise have been.
“That has led to a big shift in yield differentials in the pound’s favour,” he says. “The UK might have poor growth fundamentals and an inflation problem, but at least you get paid for running that risk these days.”
Throughout most of 2023 [the pound] has been one of the strongest and least volatile of the major currencies
Pete Mulmat, IG US
HSBC’s Bunning believes GBP volatility is likely to remain compressed, with GBP/USD range-bound in the coming months, with a soft ceiling around 1.30 and limited downside as the Bank of England delivers a final 25bp rate increase in September.
“UK domestic data remains resilient – albeit not strong – while inflation is still sticky, especially on the core measure, and wage pressures are still firm,” he says. “This could see the Bank of England maintain a slight hawkish bias in the months ahead, while the Fed shifts into a more balanced mode, limiting significant downside in GBP/USD.”
There are also some signs of deceleration and softening in certain sectors of the economy, such as housing, which will make it hard for markets to extrapolate that hiking cycle much beyond the third quarter of the year.
This limits the upside for GBP/USD, which also shows signs of broader overvaluation on a real effective exchange rate basis above 1.30, according to Bunning.
“While the downward trend is substantial, we are by no means out of the woods regarding a very complicated and volatile currency market fuelled in large part by continued inflationary pressures, interest rate moves, and a general sense of uncertainty from a variety of geopolitical events,” adds Andy Gage, SVP of FX solutions and advisory services at Kyriba.
