"Redtower Asset Management sees the currency strengthening to $1.16 per euro by year’s end, from $1.3849 today, as the world economy recovers from the first global recession since World War II. Standard Chartered Plc predicts a more stable economy will weaken the dollar to $1.55 as the Federal Reserve keeps its benchmark interest rate near zero to sustain growth, prompting investors to sell greenbacks for higher-returning assets. The 39-cent gap between the high and low calls in Bloomberg’s strategist survey is almost double August 2007’s 20- cent divide. Wider fluctuations increase the risk for so-called carry trades, where money borrowed from countries with low rates is used to invest for higher yields."
Currency volatility has increased dramatically since the credit crunch outbreak in 2008. As shown in the following chart from Bloomberg, over the short term, the 12 week volatility for Euro/USD peaked in December 2008 and then touched the bottom in March 2009, since then, the volatility has picked up significantly by more than 50%. Over the mid term and long term, the 26/52 week volatility followed a rather different pattern as they continued to trend upward into 2009. Nonetheless, the current level is well above its historical norm before 2008 when the crisis began.
Volatility can have a devastating impact on corporate performance, as exporters try to protect overseas earnings. Pittsburgh-based H.J. Heinz Co., the world’s biggest ketchup maker, said on May 28 that its profit fell in the previous three calendar months in the face of “significant FX-related cost headwinds.” Similarly, the heightened volatility in the currency market could put additioanal headwinds for those international airliners, who are already struggling for their diminishing profit base as the economy crisis deepened over time.
Moreover, higher currency volatility could restrict the international investment activities further, in the sense that it makes the cost of international merger and acquisition less predictable and inceases the cost of funding dramatically. The US conglomerate GE announced the £5.7bn deal of acquiring Amersham, the UK medical diagnostics company in October 2003. By the time the deal was completed in May 2004, the dollar had fallen 12 per cent against sterling and GE was forced to pay almost $350m more to close the deal.
Another victims of this heightened currency volatility are probably the emerging market currencies, which have had “a pretty good run” might suffer from increased volatility, as investors flee to safety investments and close their carry-trade posisions quickly.
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