It has been a wild ride for currency markets over the last year since the coronavirus was first detected. It’s been marked by bouts of volatility as well as emerging long-term trends, while there has been a complete change in the way markets decide the value of currencies.

A year ago, not many people could have foreseen that the outbreak of a virus in China would turn out to have such far-reaching effects around the world. Apart from the health implications, the widespread economic disruption caused by policies aimed at preventing the spread of the virus has had ramifications far beyond. One area where we’ve seen volatility has been in the foreign exchange (FX) markets.

When the virus was initially identified and the World Health Organisation declared it a global pandemic, the countries most closely associated with the outbreak were placed into varying levels of regional and national lockdown. In the case of China, the Wuhan region where the initial outbreak was detected is an important manufacturing hub for many of the electronics and engineered goods the world economy depends on.

BROKEN SUPPLY CHAINS AND FEAR FACTOR LED TO US DOLLAR BOOM

The subsequent lockdown caused an immediate and prolonged disturbance to supply chains as factories fell silent and workers were ordered to stay at home. This had an obvious effect on the level of risk sentiment FX traders react to when deciding how and where to invest.

As the appetite for risk declined, there was a rush to buy the US Dollar, which is considered a safe haven for investors during times of uncertainty. In just a few days at the beginning of March 2020, the Pound to Dollar exchange rate (GBP/USD) plunged from $1.31 to $1.15 as Sterling, as well as other currencies, was hammered lower. At the same time, global stock markets were also hit, with the US S&P 500 plunging 30 percent from its February highs – a record decline in such a short space of time.

Some countries react more to elevated levels of risk than others, and the Australian Dollar is one of them. Due to its sensitivity to global trade – and especially trade with China – the ‘Aussie’ saw an immediate plunge in value. Other ‘risky’ currencies, such as the New Zealand Dollar (NZD) and the South African Rand (ZAR) were similarly caught out.

NATIONAL LOCKDOWNS SAW THE RETURN OF RISK APPETITE

During April and May 2020, most countries in the world initiated national lockdowns, which caused an unprecedented slump in economic activity. Especially hard hit were the hospitality, travel and manufacturing sectors, although few sectors escaped unscathed. The knock-on effect on the price of oil was dramatic, with crude prices falling into negative territory for the first time ever.

However, the sense that something was being done – however draconian – to halt the spread of the coronavirus led FX investors to feel a sense that normality would soon return to markets, and the appetite for risk began to improve, albeit slowly.

From late March, we started to see the gradual, but sustained, deterioration in the value of the US Dollar – a trend that has continued ever since. In fact, over the past 11 months, the US Dollar has lost 11 percent of its value, although there has been some plateauing in the last month.

The upside of the US Dollar’s decline has been a sustained increase in the value of its rival, the Euro, which has gained 12 percent against the Greenback. Similarly, the Pound has seen itself strengthen over the same period, soaring 19 percent.

In the case of the Pound, the rally against the US Dollar has been more pronounced due to a number of factors, not least because of Brexit. Since 2016, Sterling has been depressed due to anxiety over whether an equitable deal with the EU could be reached, so when UK PM Boris Johnson announced a last-minute agreement, Sterling investors felt more secure in backing the currency.

VACCINE STRATEGY IS NEW FOCUS FOR FX MARKETS

One of the most noticeable effects of the Covid-19 pandemic has been a shift of emphasis from economic statistics to medical statistics as the main focus for FX investors. When all countries were hit hard by the reduced economic activity as a result of measures to slow the spread of the virus, it became difficult for investors to assess the value of any individual currency.

However, since a range of vaccines have been produced that are said to limit the transmissibility of the virus, as well as reduce its damaging health effects, FX investors have begun to focus increasingly on the level of uptake as one of the main signifiers of a return to normality.

This was illustrated clearly in the UK when the Oxford-AstraZeneca vaccine was cleared for use, and production began. The Pound immediately benefitted due to the likelihood that economic activity could resume sooner rather than later.

Conversely, when EU countries found out there were vaccine supply issues, as well as problems certifying it for use, investors took this as a signal to hold back on buying Euros until the issues had been resolved. Over that period, the Pound rose from €1.10 to €1.14 against the Euro.

WHERE DO THE CURRENCY MARKETS GO FROM HERE?

As we look out at 2021 and beyond, many people want to get a feel for how the Pound and other currencies will likely fare. Perhaps they are planning to move abroad and want to know how far their budget will stretch, or maybe they rely on sending or receiving funds and are sensitive to the daily, weekly and monthly movements of the market. What seems certain, at this stage, is that the various long-term trends which have been established still have some time to run.

Take the US Dollar, for instance. As the ultra-loose monetary policy of the Federal Reserve and the new Joe Biden administration continues to roll out, the deflationary effect this is likely to have on the US Dollar will continue. Combined with this is the perceived success and uptake levels of the various Covid-19 vaccines around the world and how fast this will lead to a resumption of normal economic activity. Both these factors will have an effect on the US Dollar.

Similarly, the Pound will likely continue to benefit from the ongoing weakness of the US Dollar, as well as the relative weakness of the Euro. Unless the Eurozone countries pick up the pace of their vaccine programmes, the Pound is likely to outpace the Euro over the short to medium term.

Nevertheless, the only fly in the ointment of this expected outcome is the possibility of new variants of the virus being identified. If these variants prove to make the Covid-19 vaccines ineffective, we’ll likely to see a return to fear in the FX markets, at least on a regionalised basis. If variants are identified in the UK this would probably have the effect of depressing the value of the Pound until the problem has passed.

MANAGING RISK AND PROTECTING YOUR CURRENCY TRANSACTIONS

If 2020 is anything to go by, the risk of 2021 seeing similar levels of volatility in the FX markets can’t just be brushed away. For anyone concerned that a sudden – or even a not-so-sudden – market ‘correction’ could occur, it can indeed lead to increased worry about the value of your currency transactions. The good news is that there are things you can do to protect yourself from much of this risk.

Established FX providers such as Currency Solutions are experts in flattening this kind of risk and can easily help you to stop worrying about market volatility. For example, they can help you set up an order that activates your currency exchange when a target rate that is right for you is reached.

If you think you could benefit from this type of service, just give us a call or contact our team and we’ll help you get on the right track for cost effective and simple currency transfers. After all, with the Covid-19 still at large, the last thing you need to worry about is a stormy FX market.