Is currency volatility a bad thing?
Low inflation and interest rates over an extended period have dampened sharp movements in exchange rates, but as consumer prices rise and interest rates are increased, currency volatility once again becomes an important element to consider when trading. If underestimated, it could lead to potentially negative consequences for some investors.
Currency volatility is generally measured by calculating the standard variance of currency price movements and provides traders with an indication of the extent to which a currency might move relative to its average over a given period. Generally, the more volatile a currency, the greater the trading risk. However, this higher volatility also creates more opportunities for traders with their resultant larger price moves.
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Rand and dollar are among the most volatile currency pairs
It is important for traders to be familiar with a currency’s volatility since different levels of volatility are more suitable to specific strategies and psychologies. Currency pairs with lower volatility are more favourable for those wishing to grow capital steadily without assuming major risks, whereas currency pairs with higher volatility are more likely to be sought after by risk-hungry traders who aim to cash in on greater price differentials.
The United States (US) dollar and the rand are considered among the most volatile currency pairs. The rand is a commodity-driven currency, the value of which fluctuates in accordance with supply and demand. Despite not achieving the average daily forex turnover of major currencies such as the dollar, the euro or the pound, the rand’s value still classifies it as one of the top 20 global currencies.
In dealing effectively with the variables that affect volatility, risk management strategies must be tailored to each client’s individual requirements.
Political, economic and social circumstances drive volatility
Volatility is impacted by various political, economic and social circumstances and events. Both the local and political environment have a direct bearing on a currency’s volatility, which is one of the reasons why emerging market currencies tend to be more volatile due to uncertain or unstable political and social landscapes.
“Central bank policies are another factor. Local interest rate hikes are seen as rand-positive, while interest rate cuts are deemed negative. International interest rates also affect the attractiveness of rand-denominated investments, in bonds, for instance. An obvious element influencing volatility is both local and international economic performance and a prime example of this is the instability surrounding the reliability of South Africa’s power supply, which currently has a negative impact.
Seeking opportunities versus your risk appetite
Volatility is often deemed to be negative as it demonstrates just how susceptible the rand is to specific events and market changes, but it also demonstrates the efficiency and liquidity of the South African market, where buyers and sellers can buy and sell currency without delay, which many traders take advantage of.
Although currency volatility can be viewed as unpredictable, the risk associated is not and individuals and companies should decide the extent of the risk they are willing and able to manage. Individuals and companies with exposure to foreign currency can protect themselves against volatility using various measures to reinforce their market position, one of which is hedging solutions.
Any associated risks must be identified, and suitable strategies, solutions and products crafted to manage them. Risk can then be mitigated through market timing, effective strategies, preferred suppliers and efficient reporting, which enables clients to adjust trading strategies and policies to suit their risk appetite and trading style.
As leaders in treasury, foreign exchange, and risk management solutions, Citadel Global acknowledges that risk management is not just about avoiding the loss in rands and cents – it is about understanding the opportunity cost and regulatory requirements involved in every single transaction in order to move money efficiently. In order to do this my team and I are always abreast of local and international current affairs that could have economic repercussions and monitor international markets holistically.
Bianca Botes is director at foreign exchange experts, Citadel Global.
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