China's record draw on its foreign-exchange reserves is proving to be a catalyst for exaggerated price swings in currency markets around the world.
The People's Bank of China slashed its holdings by the most ever last quarter to prop up the yuan after its shock devaluation in August. It's burned through close to half a trillion dollars since the middle of last year, equivalent to twice the size of Greece's economy and draining a key source of liquidity from world markets.
Swings in exchange rates responded by averaging the highest last month since 2011. And the pressure shows few signs of abating as central banks elsewhere in the developing world follow China's lead amid a commodities rout and the prospect of a dollar-boosting increase to U.S. interest rates.
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"As central-bank liquidity becomes less abundant, volatility tends to pick up," said Robert Sinche, an analyst at Amherst Pierpont Securities LLC in Stamford, Connecticut, who was global head of strategy for rates, currencies and commodities at Bank of America Corp. during the financial crisis. The "tighter liquidity conditions" as the Federal Reserve gets closer to acting, plus the drop in China's reserves, are "a recipe for volatility," he said.
While such volatility is an opportunity for currency traders to make money, it also highlights the troubles stalking global economies, particularly those dependent on exporting raw materials to a struggling China.
In late August, New Zealand's dollar briefly plunged the most in 30 years amid signs liquidity in that currency was drying up. Currency swings can reflect good news too: Malaysia's ringgit strengthened the most since 1998 on Wednesday as the nation reported a bigger trade surplus.
China reduced its reserves by a record $179.7 billion in the three months ending September, bringing the decline since it started cutting in July 2014 to $480 billion, or 12 percent of the total. It spent years building up its holdings which, at $3.5 trillion, are still the world's biggest.
JPMorgan Chase & Co.'s Global FX Volatility Index climbed to 11.3 percent on Sept. 7, approaching January's peak and more than double the record-low end-of-day level of 5.3 percent in July last year. The measure averaged 11 percent in September, the most since December 2011.
"The reserves decline in China is another signpost of nervousness of the Chinese themselves, and if that's the case, we probably all should be a little bit nervous," said Sean Callow, a currency strategist at Westpac Banking Corp. in Sydney. "It's a real turnaround to go to an environment where so many central banks are running down their reserves to defend their currencies."
The Bank of Russia has burned through about $160 billion, or a third of its reserves, over the past two years to support the ruble, which still sank to an all-time low in December. South American nations have got through less cash, though Venezuela, Paraguay and Ecuador have all reduced their holdings by more than 9 percent in the past 12 months.
Swiss Surprise
Dwindling reserves are just one of the ways central banks are stoking price swings in global currencies. Seven months before China's devaluation, the Swiss National Bank scrapped its exchange-rate peg, sending the franc soaring to a record.
And while traders have pushed back bets on when the Fed will tighten policy, the prospect of higher borrowing costs in the biggest economy is driving developing-nation currencies weaker and keeping markets choppy.
Anshu Jain, the former co-chief executive officer of Deutsche Bank AG, told Bloomberg this week that financial assets generally are headed for much higher volatility, citing interest rates. The International Monetary Fund warned in its latest Global Financial Stability Report that central-bank policy missteps risk derailing the world economy.
"It's way too early to say that volatility is a sell," said Valentin Marinov, head of Group-of-10 currency research at Credit Agricole SA's corporate and investment-banking unit in London. "The drop in FX reserves is here to stay."
Bloomberg News
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