2021 is in the books, punctuated perhaps by less crowded New Year’s Eve celebrations that folks would have liked, due to yet another wave of Covid-19 wreaking havoc on holiday plans. The last two years have introduced significant volatility from interrupted travel, supply chain problems, huge swings in labor markets, and more recently the growing consensus that “transitory inflation” may not be so transitory. As the reactions to these problems by various countries has differed, so to have their economies, and we can expect this to continue as they grapple with how (or whether?) to fight an inflation threat that is greater than it has been in decades.
Will tough talk (where it exists) by central bankers and modest rate increases (still significantly below inflation) be enough to tame inflation in the medium to long term? Japan, Europe, the United States, and other major economies have spent the last few decades in a pattern of doubling their debt rather quickly, while halving the interest rate paid on that debt. Then doing it again (and in the case of Japan, again and again). The markets have been lulled to sleep as a result, trained not to fear excessive debt when the interest payments haven’t risen substantially, assuming a new wave of record low interest rates will always come to the rescue.
However, this has been in an environment where, for several reasons, there have been global deflationary pressures that are arguably now either fading or reversing. Without those pressures offsetting the inflationary impact of negative real interest rates, those interest rates may need to rise and remain higher for longer to have a chance of fighting persistent inflation. And after years of doubling and redoubling the debt, it unfortunately wouldn’t take much time for higher interest rates to put many countries into “debt trap math” rather quickly.
The pace at which that might happen could likely cause significant volatility in stock, bond an FX markets, as the dominoes start to fall. Which country is Bear Stearns? Lehman Brothers? Much like the interconnectivity of the banking system caused pain for everyone in 2008, doing business across the globe is likely to cause pain for all FX risk managers who don’t have a good handle on their exposures and hedging processes, no matter their home country.
Volatility in almost every market is up sharply so far in 2022. Is your FX risk management house in order?