Forex Response to Global Economic Downturn

How is the generalized global economic downturn going to affect currency trading? Much has been said about the Chinese economic slowdown and how it has hurt developing countries that make money exporting raw materials to China. Now economists are looking at a slowdown in North America and Europe as business with and sales to developing nations dwindle. What will be the Forex response to a global economic downturn? Reuters reports on the global growth outlook.

The outlook for the global economy became bleaker on Wednesday as signs of a deeper manufacturing downturn in China emerged, coupled with slow growth in Europe and the United States.

“There is substantial concern at present that global demand weakness is dampening the economy in the industrial countries,” said Jorg Kramer, chief economist at Commerzbank.

A strong dollar, flagging demand in many export markets and reduced capital spending by energy and other companies all dragged on U.S. manufacturing, according to Chris Williamson, chief economist at Markit.

“The survey is indicating the weakest manufacturing growth for almost two years, meaning the sector will have acted as a drag on the economy in the third quarter,” Williamson said.

The global economy is so interconnected that slowing demand for investment and slowing economies in one region invariably affect nations across the world. The question for Forex traders is how the Forex response to a global economic downturn will affect individual currencies.

Emerging Market Currencies

The Chinese Yuan is overvalued. If the People’s Bank of China lets the Yuan float freely in Forex markets it is a fair estimate that the currency will fall anywhere from three to seventeen percent by the end of the year. Seeking Alpha says, however, that emerging market currencies are getting hit the worst and that countries with chronic deficits are the most likely to devalue.

Emerging markets have certainly been on the move. Not only their stock markets, but also their currencies. Most, if not all emerging markets, have seen the value of their currency depreciate versus the U.S. dollar. The prospect of higher interest rates in the U.S. in 2015 has contributed to the strengthening of the dollar versus other currencies.

In the last year the Brazilian real has fallen 53% against the dollar and the Colombian peso has fallen 50% while the Turkish lira has fallen 30%. The list goes on: Malaysia 23%, South Africa 20%, Indonesia 18%, Chile 15%, Mexico 15%, Russia 14% and Thailand 10%.

The Effect on North America and Europe

The global economy is interconnected. When developing nations do not have cash they do not import from developed nations. The falling value of currencies across the globe comes back to hurt exporters in the USA and Europe. Germany is a case in point. The EconoTimes comments on how emerging market problems may hit the German economy.

The economic weakness in China and other emerging markets has already hit German industry. Moreover, China’s growth is set to continue slowing down for quite some time yet, as there is a glut of unsold real estate, and the corporate sector and private households have high debt levels of 190% of GDP. All these negative factors will be too much for German domestic demand to absorb in the long run.

In the near term the Euro and USD will remain strong compared to developing world currencies. But, the eventual Forex response to a global economic slowdown will be the retreat of both the EUR and the USD. For Forex traders this will be a matter of timing.