TD Bank economists are impressed with the way currency markets have handled themselves amid a global economic and stock market slowdown.

“Although the world economy is in the grips of a major slowdown, the adjustment in foreign exchange markets to the changing economic landscape has been orderly compared to the turmoil during the 1997/98 Asian crisis,” says TD in a report out today.

“Indeed, with Japan likely in recession, East Asian and European growth forecasts being scaled lower, and a U.S. recovery looking more distant than many had anticipated, the extent to which currency markets have taken developments in stride is remarkable.”

TD says that the difference this time around is that the U.S. slowdown was less of a shock than the unforeseen problems of Southeast Asia. As well, markets have been cheered by the rapid and aggressive rate cuts, and global investors are less leveraged to the more vulnerable emerging markets than four years ago.

It says the greatest single difference, however, is the increased flexibility in exchange rates. “One stark lesson from the Mexican peso crisis in 1994 and the subsequent Asian crisis is that fixed or tightly managed exchange rates are vulnerable to speculative pressures when economic conditions deteriorate. The majority of countries on investors’ radar screens have floating currencies, which are acting as a shock absorber to the global economic slowdown.”

Although the still-pegged Argentine peso remains in the spotlight, TD says, “we believe that global contagion from either of these eventualities will be limited by the increased presence of floating exchange rates”.

TD forecasts that the trend towards flexible exchange rates is likely to continue, with Malaysia, and ultimately China expected to follow suit. “Although many countries will continue to have fixed exchange rates, their relative share of the world economy will steadily decline in the coming years. The increased use of floating currencies may increase the day-to-day volatility in foreign exchange markets, but it will also reduce the periods of extreme turmoil associated with speculative attacks.”