Currency watch: markets are calm – for now

Following a decidedly unpredictable year, the last few months of 2012 have bucked the trend and we have entered a period of relative calm.

Exchange rates have remained somewhat flat since the end of September, and this has prompted many businesses to sit back and relax a little when it comes to the foreign exchange markets.

There has been a noticeable dip in activity when it comes to UK SMEs taking action to hedge their international payments. In fact, a recent survey we commissioned revealed that only 8% have any protection in place for more than six months in advance. This is despite the fact that the debt crisis in the Eurozone has not been resolved and the threat of the US ‘fiscal cliff’ looms across the pond.

Fluctuations in the value of currencies have been a hallmark of the financial crisis to date. And, if you are looking at a long term budget plan, leaving yourself unhedged might be a dangerous tactic despite this short term lull.

Recent comments from ECB chief Mario Draghi that the euro is ‘irreversible’, and the extension of quantitative easing in the United States for seemingly forever, has combined to reassure investors that the central banks will act as a more substantial backstop in future. I envisage that we are going to see a strong shift away from debt dynamics in the coming few years.

The debt crisis panic which has characterised 2012 will turn into a lingering, nagging fear over growth. The translation of this in the currency markets may mean that volatility continues to slip for now, but businesses should not confuse this for an indication that range-bound trading is here to stay.

The levels of volatility in the major pairs are currently returning to the levels seen pre-crisis. It may however, come as a surprise to most businesses that in GBPUSD for example, the swing between the high and low in the course of a trading year averaged at 12.3% between 2003 and 2006; a time that was typified by calm, almost predictable markets.

Factor in the credit crunch, recessions, debt defaults and bank bailouts and that average has only increased to 14.77% and anybody suggesting that you would be better off to not hedge against your exposure during that period was clearly mistaken.

In fact nobody knows when things may change, and anyone who tells you otherwise is bluffing. It’s all about protecting yourself and taking a long term view. Effective planning is very difficult unless you take a strategic viewpoint on the currency markets because they are notoriously fickle.

Jeremy Cook is chief economist at World First foreign exchange.