Recent Market Turbulence.

The 1970's and 1980's witnessed a trend to increasing volatility and unpredictability in foreign exchange markets.One reason for this development was a dramatic increase in the number of market participants trying to take advantage of exchange-rate moves.In addition,the technological resources available to these traders ,financial managers,and corporate hedgers had improved substantially.

In the early 1990's,bank and investment dealers continue to be major players in the markets,but their terms of reference tend to restrict their activities primarily to trading.Corporations are frequently active in foreign exchange risk management and often utilize selective hedging and/or trading programs.Their trading decisions can have significant impact  on currency markets in both the short and long term and are sometimes underestimated as a factor in the marketplace.Individuals can also be major factors as they access the market through different mechanisms,including the futures markets and purchases of foreign currency stocks and bonds.

It should be recognized that traders,whether a corporation, a funds manager,a banker,or an individual,need volatility to make money.These agents usually do not care which direction a currency move takes.The key is that the exchange rate moves and thus provides profit opportunities.

A second reason for market turbulence is the increasing payments imbalances among countries.Capital now flows freely among the major currencies in response to trade and service account deficits and surpluses,and the large increase in pensions and other investment funds provide ready sources of funding.In addition,public and private borrowers also tap various foreign currency markets,and as this capital moves from currency to currency,significant pressure on exchange rates often result.

While both pools of capital and financing requirements were growing,global markets experienced volatile interest rates,which also increased the size and frequency of major capital flows.Excessive inflationary pressures arose in the 1970's,caused by price increases in oil and other commodities,excessive wage demands,rapid growth in credit and money supply,differing attitudes to inflation by central banks,and inflationary expectations.Capital will often flow to currencies which attractive interest rates,and at times major strengthening moves in currencies have been aided or even caused by interest-rate differentials.However,when those interest rates were no longer attractive,the capital would move out,and the currencies often weakened dramatically.

A related factor compounding to volatility in the markets has been the increase in U.S dollar-denominated assets owned by foreigners.The U.S dollar is the world's dominant currency and major moves in it affect almost every other currency.While foreign holdings of dollars increase global market liquidity,they also increase the size of international capital flows that occur from changes in interest-rate differentials and payments imbalances.For example,if the market turns bearish,or negative on the dollar,there are a large number of market participants who can and do aggressively sell dollar assets.

Patrick Abboud
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