Date
11 December 2017
Too much liquidity in the financial system can make markets volatile, as it contributes to asset bubbles that inevitably burst. Photo:HKEJ
Too much liquidity in the financial system can make markets volatile, as it contributes to asset bubbles that inevitably burst. Photo:HKEJ

More market crashes to come this year amid forex volatility

There is a good chance of financial crises this year given that the volatility of financial assets like equities, crude oil, metals and bonds has gained momentum since mid-2014.

Looking back at several financial crises last century, like the bursting of Japan’s stock and property bubble in the early 1990s, the Asian financial crisis in 1997, and the US subprime crisis in 2007/2008, all were related to excessive liquidity and the consequent asset bubbles.

If the financial system is flooded with liquidity, any market shock or sudden tightening of liquidity may lead to significant market volatility.

Liquidity is abundant after six years of monetary easing. When the US Federal Reserve raises interest rates, credit will reverse to tight from loose.

The exceptionally strong US dollar has sent prices of various commodities plunging, so their markets will become very volatile in the first half of this year.

The Swiss National Bank’s decision to abandon the franc’s cap against the euro last week will have a tremendous impact on the market.

It will have an impact not only on foreign exchange traders and related hedge funds but also on the Swiss economy and company earnings.

Exports account for over 60 percent of the country’s gross domestic product, and Swiss firms generate 85 percent of their sales revenue from overseas.

The move, which has undermined the credibility of the Swiss central bank, will have ripple effects on various sectors.

This week, the market is closely watching the European Central Bank’s meeting Thursday.

A Bloomberg survey shows 93 percent of 60 economists expect the ECB to roll out a 550 billion euro (US$637 billion) bond-purchasing program in an attempt to stimulate economic growth.

However, the expectation of ECB monetary easing has already been priced into the market, more or less.

In fact, the correlation between the euro/dollar exchange rate and the assets of the two central banks has disappeared since mid-2014, as investors have already priced in the Fed’s rate raising and European quantitative easing.

The Swiss move, however, has not been fully reflected by the market, in particular its potential shock on eastern European economies.

However, if the ECB meeting fails to meet market expectations, investors might rush to close short euro positions to make up for the huge losses they suffered in the Swiss franc.

If so, the euro may rebound in the short term, and investors should then reduce their exposure to the currency.

This article appeared in the Hong Kong Economic Journal on Jan. 22.

Translation by Julie Zhu

–Contact us at [email protected]

JZ/JP/FL

Hong Kong Economic Journal chief economist and strategist

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