Advanced Forex Blog

Forex and Covid-19 – How The Pandemic Affects The Currency Market

February 27, 2022 | 4:59 pm | Advanced Forex Blog
February 27, 2022 | 4:59 pm
Advanced Forex Blog
Forex and Covid-19 - How The Pandemic Affects The Currency Market

Forex and Corona

Since the beginning of 2020, the covid pandemic has significantly affected the Forex markets which caused the fall of sterling against the US dollar by 15%. The volatility in this period created a difficult valuation environment that hasn’t existed for many years.

In that situation, commercial banks and corporations using Forex products can better understand the impact of increased Forex market volatility on their balance sheets. Also, the banks considered the potential risks to valuation and financial reporting. These actions allowed the end-users to maximize the values of their portfolios. 

In this article, you can find a new version of the analysis about the effects of daily contaminations on the financial markets, which incorporates the recent third wave.

 

Relation of Forex and Covid-19

At the start of the Covid crisis, investors have tended to buy the American dollar, especially against emerging market currencies, as a popular trading strategy in the Forex market. As it often does during difficult market conditions, the dollar has served as a safe-haven currency during the crisis.

The following are three main reasons why the dollar has outperformed:

  • In terms of liquidity, it is the most liquid currency globally.
  • It is less reliant on external demand than most developed nations, including Europe.
  • Through much of the outbreak, the spread of the virus in the US was relatively less vigorous than in Europe and Asia, especially when measured by the number of people infected.

 

Financial market conditions at the start of the pandemic

During the ten days following March 10th, 2020, the dollar appreciated by about 8% trade-weighted, though it has since given back some gains.

Over the first few weeks, EUR/USD has been very volatile, rallying sharply and then crashing to a near three-year low above the 1.07 level.

 

EURUSD crashing to a near three-year low

 

Suppose the interest rate differential between the United States and the Euro Area narrows in the future because of the Federal Reserve’s zero-rate policy. In that case, investors will no longer have a reason to buy the euro.

Besides the US and Canadian dollars, the Norwegian krone, Australian and New Zealand dollars, and sterling have been among the most exposed.

On 18th March 2020, the pound fell to its lowest level against the dollar since 1985.

In the pair, implied volatility measures have skyrocketed, outpacing levels seen following the Brexit vote in June 2016 during the current crisis – groups that were thought unlikely to be repeated in a generation.

The extreme selling of the pound occurred by investors unwinding positions that they accumulated following the UK election in December, as well as the higher risk premium associated with Brexit and the country’s large external deficits.

 

Result of a pandemic on GBPUSD pair

 

 

Impact of corona on global Forex Markets

Daily COVID-19 contaminations strongly impact forex exchange market volatility regardless of the degree of development in most countries studied, namely the United States, Europe, Switzerland, Japan, South Africa, China, and Turkey. This is because they all have open economies and rely heavily on global supply chains (including Europe’s proxy).

The country’s currency market became more sensitive to COVID-19 data, mainly the daily contaminations, as the pandemic evolved and authorities implemented strict sanitary measures (lockdowns, travel bans, capacity reduction). A surge of contaminations from COVID-19 also boosted demand for gold, U.S. dollars, and Swiss francs as investors sought a haven.

Moreover, in the cases of Russia and India, we observe that Daily COVID-19 contaminations have a strong impact.

The very high correlations may be due to both economies having significant exposures to commodities or exports services, both of which were heavily affected by the COVID-19 pandemic.

It is also likely that the market participants believe that the country is in the early stages of a prolonged bear cycle, and they are uncertain about the pandemic’s progression and effects on its industrial and service sectors.

Additionally, both countries have taken similar measures on the macroeconomic front to address the socio-economic hardships of the pandemic crisis.

Among these policies were reducing key interest rates, reducing macro-prudential banking rules, and loosening inflow controls.

As a result of the managed float regimes, the central banks intervened heavily to stabilize the external value of their currencies, which caused large fluctuations in forex volatilities. 

 

 

 

Impact on pricing and hedging 

Hedging against forex volatility with forwarding contracts has been a mainstream strategy for corporate and commercial banks.

The current volatility in the forex markets will affect the value of these contracts, particularly since the 2Y GBP/USD forward rate dropped by around 15% at the start of the pandemic. However, the recovery since then has been lackluster, with rates still trading about 10% lower than they were at the beginning of the year.

 

A sharp downfall of prices with the rise in pandemic

 

Moreover, the volatility of currency markets can significantly impact the valuation of Forex derivatives and foreign currency assets and liabilities within a day.

In light of this, strong diligence and consistency must be applied to the timing of valuation cut-offs, as well as the performance of sensitivity analyses to identify how explosive growth is likely to impact valuations and operations.

It would also be appropriate to reevaluate the treatment of derivatives under hedging arrangements.

 

How will the pandemic affect the currency market in the future?

Predicting the global economic recovery after a pandemic is challenging as there are a lot of variables to take into account.

Every time we see new virus variants or changes in the perception of vaccine efficacy, we witness how quickly things can change, making the forex markets even less predictable.

Despite a bleak economic outlook, the UK is optimistic about its future health since many of society’s most vulnerable members have received immunizations, which are considered highly effective in preventing serious illnesses.

After a long period of lockdown, the British pound will surge as consumers and tourists rush back into the country after the summer and the reopening of businesses.

Currency values may fluctuate as different areas embark on their plans to recover, as market participants remain aware of the risk and the many variables at play.

 

Forex and Covid Bottom line

COVID-19 contamination continued to significantly impact economies variously (except the UK and South Korea), with even greater results in the cases. There was a significant influence of COVID-19 vaccinations on all the countries studied, particularly those in the Eurozone. Most market participants express optimism regarding the pandemic’s evolution and impact on the financial market, except Switzerland, Russia, and India.

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