Why to expect more currency volatility

An acceleration in “drawbridge capitalism” is expected to affect global capital flows and encourage more currency volatility, PIMCO’s Gene Frieda says in a market commentary on Thursday.

Protectionist policies putting domestic business first — what Frieda calls “drawbridge capitalism” — will accelerate a retreat from globalization and deepen correlations between geopolitics and international trade. The trend will heighten U.S.-China tensions and encourage capital flows and currency volatility.

“The U.S. version of drawbridge capitalism is likely to lead to renewed volatility in foreign exchange markets,” writes Frieda, a London-based global strategist.

He adds: “The [Donald] Trump administration believes that most trade agreements have been disadvantageous to the U.S., and that many key trading partners have engaged in mercantilistic currency policies. U.S. efforts to force appreciation of currencies benefiting from large trade surpluses and to renegotiate trade accords are likely to backfire as capital outflows from targeted countries override trade considerations.”

Read: How to invest with inflation on the horizon

Frieda says the Chinese currency will be a bellwether for how U.S. policy stimulus is transmitted to the rest of the world. Pronounced Chinese currency depreciation, possibly stemming from a need to support domestic growth and financial system stability, would lead to a large deflationary shock for the rest of the world, he says.

A U.S. recession, caused by a slump in Chinese and emerging market growth, would be more likely than any kind of “Plaza-like exchange rate coordination.”

Frieda says: “Combining experience from the 1980s and 1990s, the dollar’s overshoot is likely to end at a point when China is no longer willing or able to sustain capital outflows and depreciation pressure.”

Also read:

Global economy expected to accelerate slightly in 2017

Don’t be too bullish on 2017 growth

How to capitalize on market fear

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.