ANIMAL spirits are patrolling the forex kingdom. The question is: what creature does the currency market most resemble right now?

“A goldfish,” says Peter Kinsella, currency analyst at Commerzbank, “swimming around in the dark with absolutely no memory.”

“A lazy chicken,” ventures Matthew Cobon, fund manager at investors Columbia Threadneedle. “Capable of producing the golden egg but often generating periods of noisy clucking.”

The psychology of the forex market is difficult to read at the best of times, and these are hardly them. The euro-dollar spot rate went through a rollercoaster ride last Thursday, up and down a 1.3pc range in a few hours.

In a year of extreme swings, currency strategists — the psychologists of the market — are having it tough, and are expecting it to get tougher.

“These past few weeks have been particularly challenging for traders and strategists alike,” wrote David Woo, FX and rates strategist at Bank of America Merrill Lynch. “There has been a lot of volatility, but no clear trends to hang our hat on.”

Times are hard for the forex market’s psychologists, and things are likely to get tougher

This week sees the release of a tide of economic data, including from the US on retail sales and jobless claims, and from the EU and Japan on GDP. But there will be even more attention on the bond market, probably the key driver behind last week’s euro-dollar volatility.

This volatility is wreaking havoc on strategists’ forecasts. A few months ago, several were predicting the euro’s swift descent to parity with the dollar, only for the US economy to stall and send the dollar down.

Others were confident that the dollar-yen trade would hit Y125 by the end of the year. It hit that mark on last Friday.

“It’s tough to make any sort of calls in a volatile environment,” says Jane Foley, senior currency strategist at Rabobank, who steered clear of a euro-dollar parity forecast. “But it’s part of the job. Ultimately, our job is to see through some of the noise.”

Explanations for this volatility are numerous. “Some people call this volatility,” says Steven Englander, Citigroup’s head of G10 FX strategy, “but it’s another word for liquidity”, which is drying up. Investors and traders are simply not as willing to take positions as they once were, he points out.

The summer is likely to be tougher, a period when lack of liquidity traditionally stalks the forex market.

Whatever is driving the forex frenzy, the currency market is weak, says David Bloom, head of FX research at HSBC.

The market is ‘very docile’, he says, responding seemingly at every turn to a central bank governor’s utterance.

After European Central Bank president Mario Draghi told the market last week to ‘get used to’ volatility, the remark ended up being a self-fulfilling prophecy.

Mr Englander can smell the intrinsic nervousness among traders in a climate in which positioning is everything. The climate “makes people really cautious about the positions they have on, and everyone becomes a technical trader”, he says. The instinct of traders and investors to bond yield moves such as those last week is ‘to get out of the way’.

What troubles some analysts is a series of inconsistencies. Mr Woo points to three: the ‘puzzling’ divergence between US household incomes and spending; the Bund sell-off coinciding with positive eurozone data; and the growing convergence between US and eurozone inflation when theoretically they should be diverging.

The problem, says Mr Kinsella, is the short-termism of the market, at the expense of the need to focus on the underlying weakness in the global economy, particularly the eurozone.

Is it a cautious market, a nervous one, an impatient one, or, as Mr Bloom suggests, one driven by fear?

“When fear drives the market you don’t want to be contrarian. When everyone says euro-dollar is going up, you buy it. When they say it’s going down, you sell,” he says. “You don’t want to stick out against the market.”

Ms Foley describes the market as calm and considered at some times, moody and unpredictable at others. “A big cat with toothache,” she says.

Published in Dawn, Economic & Business, June 15th, 2015

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