Morning Commentary: Fixed Exchange Rates – the Return of Bretton Woods?

Foreign Exchange - Morning Commentary
Fixed Exchange Rates – the Return of Bretton Woods?
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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
There is a spark of life in the markets today as improving economic data out of the U.K. and Germany have pushed European equities and interest rates higher with a positive ripple effect for the U.S. The better-than-expected data is a welcome change from the constant drumbeat of continuing concerns about the EZ being one of the major drags for the global economy. Commodity prices are continuing their resurgence and commodity-linked currencies are outperforming today.
But outside of today’s economic data sparking some foreign exchange movement, foreign exchange has been badly lagging behind the directionality, price movement and volatility of equities, interest rates, and commodities. With the exception of the GBP due to Brexit concerns, many of the other major currencies have been in the doldrums characterized by tight overnight ranges and trapped in broad consolidation patterns. Implied volatility, a metric to measure currency volatility, has dropped by 25% since the beginning of the year and is approaching lows not seen since 2014.
At times, it is almost characteristic of exchange rate movements under the Bretton Woods Agreement of 1945 where currencies were fixed against the U.S. dollar, saw only microscopic movements each day, and were locked into ultra-narrow ranges. That all came to an end when President Nixon took the U.S. dollar off the gold standard (1971) and currencies freely floated shortly thereafter with enormous volatility and directionality.
Some might say that a lack of volatility and directionality is good, as it is a sign the markets have reached an equilibrium point and have stabilized. But there is also the risk that when volatility gets this low, a catalyst of some sort can spark an outsized move where price action becomes exaggerated, erratic, and random, making it difficult to conclude transactions for both clients and traders alike. Tomorrow’s Fed announcement could provide a short term catalyst for the markets, but more than likely, we will continue to remain locked into the previous pattern of tight ranges and range bound foreign exchange rates.
  • The German ZEW business survey for March regarding business expectations came in better than expected. Expectations were for a print of -11.0, but instead, the survey came in at -3.6 after February’s -13.4.
  • Despite all the pessimistic articles about U.K. business planning being on hold or actually moving to other financial centers due to Brexit and the ever eternal negotiations,, the U.K. job market remains very strong. The UR rate fell from 4.0% to 3.9% (lowest level since the 1970s). In addition, wages and earnings also remained strong at 3.4% YoY. The British pound moved up sharply in response to the data but has given back much of its gains.
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