Lagarde Foresees the Taper to Add FX Volatility

by on February 27, 2014 5:04 am BST

Christine Lagarde, managing director at the International Monetary Fund (IMF), foresees volatility in the currency markets as the Federal Reserve continues to wind down their massive monthly asset purchases, which currently stands at $65 billion per month. Market participants have already see large moves in emerging economy currencies, such as the Turkish lira and Indian rupee and South African rand. The Chinese yuan just reached a 20-year low against the dollar within the last week.

However, traders are rejecting Lagarde’s predictions as complacency begins to set in, believing that the turmoil in numerous emerging markets will not cause contagion. The average implied volatility in the large emerging markets of Brazil, Turkey, South African, Indonesia and India are at three month lows. These five countries, particularly, were at risk, according to Morgan Stanley due to the vulnerability of large-scale capital fight.

Even though traders are willing to through the last few months of US economic data out with the bath water, there is still a risk that volatility can ripple through the forex markets. According to Yuji Kameoka, chief FX strategist at Daiwa Securities Co., said “a jump in volatility starting from emerging markets is unlikely as long as the recovery in developed economies continue.”

However, there are still key concerns. Weather or no weather, the US economic took a step back in the last few months as labor market concerns continue to be underrated. Analysts love to focus that there has been a reduction in layoffs without acknowledging that there is a reduction in hiring.

It is likely that the mediocre growth in the United States will not be sustained without the Federal Reserve’s crutch. Volatility is a trader’s playground, and it looks like recess is just around the corner.