Why currency volatility could be the market's 'Achilles heel' in 2025
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- 2025 will be dominated by currency volatility that could lead to a "sharp" correction, KKR said.
- Trade wars, fiscal instability, and geopolitical tensions will spur FX volatility.
- Currency jitters triggered market drawdowns in the late 1990s, KKR said.
Investors may be underestimating the threat to the bull rally posed by wild moves in the foreign exchange market.
KKR wrote in its 2025 outlook this week that currency swings will become the market's "Achilles' heel" next year.
"Our bottom line is that this is not the time to take a lot of excess exposure risk on FX, as it may prove to be the dominant story of 2025," it said.
The firm said investors should brace for trade wars and widening fiscal imbalances to turbocharge foreign exchange volatility beyond recent norms.
Tariffs will likely upend interest rate coordination worldwide, while economic friction causes further disruptions. Monetary policy helps dictate currency levels, and big changes can spur instability.
Meanwhile, high levels of government debt can slash demand for a country's currency, triggering devaluations.
KKR urges investors to consider how the market behaved between 1994 and 2000. After interest rate hikes first rattled markets in 1994, the stock market went on to rally, similar to what has happened since 2022, KKR said.
"However, things became unsettled in 1998, as a combination of currency unwinds and excess leverage led to a short and sharp market correction that investors were underestimating," the outlook noted.
Investors can already see this taking place in some markets.
Debt and stock markets in Brazil have been shaken this week amid a deep plunge in the country's real. The currency has become the worst performer against the dollar, hitting a record low on Wednesday.
Brazilians have been dumping the real since late November after proposed austerity measures failed to satisfy investors concerned over the country's widening fiscal deficit.
Still, KKR is largely optimistic about 2025. The firm expects the S&P to reach 6,850 by year-end, before racing toward 7,500 in 2026.
"To be sure, we expect plenty of volatility, consolidations, and drawdowns along the way to our 2025-26 price targets," KKR wrote, suggesting that investors couple mega-cap tech exposure with cyclicals, as well as small and mid-cap stocks.