by Philippa Rowat
Even by recent standards, the last month has been a volatile one in the FX markets.
The reason for the uncertainty swirling around was the prospect of the two largest and most important central banks, the Federal Reserve in America and the ECB in Europe, taking further policy action.
Unemployment in America remains stubbornly high and the Fed wants to ensure economic recovery improves over the coming year.
The situation in Europe is more serious. Spain and Italy are in danger of losing market funding and needing a fully-blown bailout. Scary stuff indeed.
Markets are forward-looking, and were in a frenzy trying to guess what action each central bank might take weeks before the announcement. Investors wanted to make sure they were positioned correctly to take advantage of any subsequent move.
Unsurprisingly, with central bankers and politicians tight-lipped, sentiment about the exact details changed frequently and that filtered through into very choppy FX markets.
As it turned out, both the Fed and ECB took very aggressive action and the moves complemented each other in terms of currencies.
The Fed announced open-ended quantitative easing and tied the outcome to a declining unemployment rate – i.e. they would keep going until unemployment dropped to what it considers a more appropriate rate – and the move led to a sharp decline of the Dollar across the currency markets.
In Europe, before the ECB announcement, there was a genuine break-up risk associated with holding Euros and this was driving a general decline in the single currency.
A vicious circle was developing between perceptions of the Euro breaking up and investors and businesses reacting to the threat by selling their Euro holdings, fuelling further declines in spot markets.
The ECB action broke the self-fulfilling aspect of the circle and has bought time for EU politicians to try and push through the reforms needed to EU-wide policy, e.g. moving towards a banking union and mutualised debt, to make the single currency a viable long-term prospect.
But the relief markets felt in the immediate aftermath of both announcements seems to be turning once again to mild concern.
The Euro is once again sliding against the Pound and the US Dollar, the traditional safe-haven is clawing back the losses it suffered over the last two weeks.
The main concern remains that monetary policy is not the answer; it can only buy time to politicians to make the structural changes needed.
The problems in America and Europe remain the same as they ever were, a large scale deleveraging by businesses and consumers and until this process is over, which may take years, markets will remain volatile and nervous.
