Currency Blocs Tied To Euro, Dollar, Yen Seen Raising Volatility

The creation of large currency blocs linked to the dollar, the euro, and the Japanese yen will increase volatility on foreign exchange markets, according to an expert on global capital flows.

"People think the bigger a currency is, the more sluggishly and slowly it moves," said Avinash Persaud, managing director and head of global research for financial markets for State Street Corp.

"The fact is, the less impact currency moves have on a particular market, the more volatile they can become."

Tracking currency risk and capital flows is the London-based analyst's main task at State Street since he joined the Boston-based banking company on March 18.

Mr. Persaud, who until recently served as head of currency and risk analysis at J.P. Morgan & Co. in London, is the architect of several risk management and foreign exchange indexes used to predict capital flows and currency changes. They include the EMU Conversion Grid, the Risk Appetite Index, and the Even Risk Indicator.

The 32-year-old Barbados-born analyst noted that the United States, which has the world's single biggest economy and capital market, has long supported large swings in the value of the dollar against other currencies.

Introduction of the euro in Europe and growing ties between the yen and other currencies in Asia have created two more large currency blocs better able to withstand bigger swings on foreign exchange markets, he pointed out. This factor, he added, contributed heavily to a sharp drop in the value of the euro against the dollar since the euro was introduced less than three months ago.

"We are going to see an increasing polarization of foreign exchange markets," Mr. Persaud said. "Currencywise, the world is becoming a more volatile environment."

At State Street, Mr. Persaud's main tool will be Global LinkSM, the bank's proprietary electronic analysis, trading, and settlement system. The system was developed to help State Street control the $4.8 trillion worth of global securities for which it is custodian.

"Banking is in essence an information business, and the banks of the future will be those who grab the technology," Mr. Persaud said.

Though the custody assets at State Street represent only around 10% of all outstanding securities worldwide, he said, they still give the bank an excellent perch from which to "see what is happening to a very large and representative chunk of tradeable securities."

"Knowing where the flows are going and where they are coming from can offer a good perspective on the future and on the risks," he said. But he also noted that, paradoxically, the increase in risk management tools is contributing to faster swings in capital flows.

"Risk management tools are making people more short-term," he said. "There is clearly something wrong there which we may need to rethink."

At State Street, Mr. Persaud presides over a Boston-based team of three strategists who work with Rudi Dornbusch, professor of economics at the Massachusetts Institute of Technology, Ken Froot, a Harvard University Professor of Finance, and Marty Weitzman, an asset allocation specialist.

Three more strategists will be added in London as part of the bank's drive to improve analysis of capital and currency movements.

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