Currency Angst Signals Worse to Come for Investors
The comments below are an edited and abridged synopsis of an article by Garfield Reynolds
Foreign-exchange traders are more nervous than at any time since the pandemic meltdown, underscoring concerns that the worst is yet to come for risk assets this year.
Developed-market currency volatility just surged past highs generated by the war in Ukraine and the Fed’s initial interest-rate hike for the cycle, while the Treasuries fear gauge has approached last month’s peak.
Anxiety in foreign-exchange markets has been led by the spike in yen implied volatility, as the currency suffers collateral damage from the policy divergence between Fed Chair Jay Powell and Bank of Japan Governor Haruhiko Kuroda.
Powell and Kuroda are offering radically different signals, but the zeitgeist from bond and currency markets is that recessions are coming for numerous economies, just as the antidote of central-bank stimulus that investors have come to rely on is off the menu.
Currencies and bonds imply that inflation will prove far more resilient than GDP growth. The devastation to the economies of Russia and Ukraine, and the damage to China from Omicron, will result in further supply shocks driving commodity-fueled inflation higher still.
That underscores the likelihood that Treasuries curves will go on flattening along with eurodollar futures as recession risks intensify.
The US dollar will strengthen, as will the cost of options used to hedge against the sudden reversals that continue to hit Treasuries, currencies and commodities.
The shoe that has not dropped is stocks. Equity volatility is busting out of relatively tight ranges; gauges of implied volume for US and Japanese indexes jumped to more than 1.5 points above their 50-day moving averages.
Currencies and bonds remain on edge, and if equities start to feel the same sort of sustained fear, then 2022 can get a lot worse for most investors.
Reynolds discusses the US, Japan and China, and their different approaches to problems that lie ahead.