(c) 2013, Bloomberg News.

(c) 2013, Bloomberg News.

NEW YORK Diverging economies are becoming a bigger influence over the foreign-exchange market as the prospect of the Federal Reserve reducing its unprecedented stimulus measures raises volatility.

The pound, euro and Swiss franc were among the five best performers over the past three months of 16 major currencies tracked by Bloomberg, as their economic data showed the biggest improvement over forecasts, according to Citigroup Inc.'s Economic Surprise Indexes. The New Zealand and Australian dollars were among the biggest losers as their countries' data fell short of estimates.

"We're back to basics," Kiran Kowshik, a London-based currency strategist at BNP Paribas SA, wrote in an Aug. 19 emailed response to questions. "The withdrawal of easy-money assumptions in the U.S. and the downgrade to Chinese growth, the two big drivers since 2009, are exposing the underlying fundamentals more clearly."

With the Fed preparing to reduce its $85 billion of monthly bond purchases, investors are turning against the currencies of nations whose economies are slowing or have current-account deficits. Emerging markets have seen an exodus of cash, with their 20 most-traded currencies plunging 5 percent in the past three months, more than in any quarter since September 2011, according to data compiled by Bloomberg.

"Between 2004 and 2007, it was all about interest-rate differentials and predictable monetary policy," Kowshik said. "After the crisis in 2008, it was a liquidity-driven move, driven by the Fed's quantitative easing."

Economists predicting that U.S. growth will quicken to 2.7 percent next year from 1.6 percent in 2013 are also forecasting that China will expand 7.5 percent this year, down from an 8 percent median estimate in May, data compiled by Bloomberg show.

As economies decouple, the JPMorgan Global FX Volatility Index is rising. The gauge jumped to 11.96 in June, the highest level in a year and up from 2012's low of 7.05 in December.

China buys a third of Australia's merchandise exports and, combined with the end of the South Pacific nation's mining- investment boom, its slowdown helped weaken the local dollar by 7.9 percent in the past three months.

The currency known as the Aussie posted the third-biggest decline among its major peers after the Brazilian real's 19 percent drop and the South African rand's 8.4 percent slide, data compiled by Bloomberg show. New Zealand's dollar, or kiwi, posted the sixth-biggest drop, at 3.4 percent.

Citigroup's Economic Surprise Index for New Zealand fell 91 points over the past three months to minus 14.3, the biggest slump among 16 countries and regions tracked by the lender, while Australia's fell 61.1 points to minus 8.3.

The gauge for Britain jumped 125 points since May 21 to 110, the biggest improvement. The euro area's gauge rose 111 to 36.9, and Switzerland's gained 105 to 87.3. A positive reading suggests economic releases have been generally better than economists' estimates in Bloomberg surveys.

"If I had to abstract one driver" for currency markets, "it would be economic data," Adnan Akant, the New York-based chief investment officer for foreign-exchange at Fischer Francis Trees & Watts Inc., which oversees $56 billion, said in an Aug. 21 phone interview. "You can see that already in the U.K., where the data trumps forward guidance."

Bank of England Governor Mark Carney said this month that he doesn't expect to raise interest rates from a record-low 0.5 percent until at least 2016, though after jobless data beat forecasts he may find it difficult to stick to this pledge.

Sterling had the fifth-biggest gain among major currencies in the past three months, strengthening 3.5 percent versus the dollar. The Swiss franc posted the biggest jump, at 5.6 percent, while the euro, whose economy emerged from a record-long recession in the second quarter, was the third-best performer, with a 3.7 percent advance.

"Data we've had from the U.K. and the euro zone have been clearly better than expected, and that has fed into stronger currencies," Daragh Maher, a foreign-exchange strategist at HSBC Holdings Plc in London, said in an Aug. 20 phone interview.

The U.S. currency is also benefiting from expectations that the Fed will reduce monetary easing, with the Bloomberg Dollar Index, which tracks the greenback against 10 peers including the euro, franc and pound, gaining more than 5 percent over the past 11 months.

Fed policymakers were "broadly comfortable" with Chairman Ben Bernanke's plan to start reducing bond buying later this year if the economy improves, with a few saying tapering might be needed soon, minutes of their last meeting showed.

"Almost all committee members agreed that a change in the purchase program was not yet appropriate," and a few said "it might soon be time to slow somewhat the pace of purchases as outlined in that plan," according to the record of the Federal Open Market Committee's July 30-31 gathering released yesterday in Washington.

"The U.S. dollar will be a leader as the economy is recovering better than the others," Maher said, adding that it's possible to overstate the link between economies and currency performance.

The 60-day correlation between the Bloomberg U.S. Dollar Index and the Economic Surprise index of the U.S. was minus 0.06 yesterday and the 365-day correlation was zero. A reading of 1 means they move in lockstep, while minus 1 means they move in opposite directions.

"We're not getting that kind of very clean reaction function between currencies and some of the economic data," said Maher.

A strategy known as the carry trade, which depends on wide differences in interest rates, is becoming less important as central banks cut borrowing costs to record lows to stoke growth.

Deutsche Bank AG's G10 FX Carry Basket index fell 9 percent in the past three months as it became harder to profit from borrowing in low interest-rate currencies to buy currencies in economies with higher-yielding assets. The gauge has tumbled to 111.22, from an almost five-year high of 125.37 in April, and is more than 25 percent lower than the record reached in July 2007, just before the global financial crisis took hold.

Differences between the Fed's tapering and other countries' accommodative monetary policies are still driving currency markets, according to John Shin, a senior Group of 10 foreign- exchange strategist at Bank of America Corp.

"It's really a country-specific issue now in G-10 and part of it is because of policy differences country by country," Shin said in a phone interview from New York on Aug. 20. "Economic fundamentals are also driving the rate differentials."

_ With assistance from Joseph Ciolli and Ye Xie in New York.

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