Foreign exchange debate part two: If it ain’t broke, don’t fix it
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Executive summary
• Emerging markets still offer many of the most interesting trading opportunities
• Dollar versus G3 and dollar versus emerging markets are the two fundamental trades
• China will be a key story in the next 12 months
• Liquidity is back to normal in most currencies but not in longer-dated derivatives
• Cash volumes are down and the macro-economy is uncertain
• The changing structure of the interbank market is fundamentally affecting the nature of liquidity |
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Foreign exchange debate: Learn more about the panelists
Simon Brady, Euromoney Let’s start with the macro-economy. Two of the key topics are the US dollar and the emerging markets. Stuart?
SF, Threadneedle Most people have been bearish on the dollar and clearly dollar weakness has come through against emerging market and commodity currencies. We look at the market from a psychological perspective, because we do feel that in these currencies the market can get over-positioned – so at some stage you can get a violent snap-back. Therefore we tend to be very aware of how news and price relate in the market. If a piece of news or economic information comes out and is very positive, and the market doesn’t react, that tells us that the market has over-bought a story or specific currency. So we tend to take our positions off and then hope for a retracement to get back in again.
We think the majority dollar view is tied in with equity markets: it is a risk-on/risk-off trade. We feel also that emerging market currencies against the US dollar are going to continue to offer value, because many have both a yield advantage and the advantage of underlying economic growth – for example, the Brazilian real and Hungarian forint.
In foreign exchange trading you have to be flexible and to trade crosses that you perhaps traditionally would not have. For example, trading Brazilian real against South African rand is an interesting play on relative growth. We are quite happy to put on that kind of trade, although clearly you need to watch liquidity conditions. That has been very much our approach from an investment perspective, and we don’t see that changing as we move into next year [2010], apart from, perhaps, dollar/yen. We don’t feel that Japan can see an economic turnaround with a very, very strong Japanese yen. There are a lot of people in the market who think dollar/yen should be at 70 and I have heard the number 50, which I can’t quite believe as I am in the 110 camp, but this has not proved a profitable trade this year [2009] unless you played it against the Aussie or the euro, which was a range-bound cross.
SB, Euromoney What about Record? What have your clients been doing and thinking about the dollar?
JWC, Record We take a different approach probably to a number of our peers in that, as a purely systematic manager, we don’t have firm views on any currency. Instead we have systematic approaches that we apply to deliver the outcomes that our clients have hired us for.
What we do see, certainly, talking to clients and particularly talking to US clients, is a widespread expectation of continued dollar decline: there are a lot of dollar bears out there in the US who take that view because they need to protect against imported inflation and the risk of dollar depreciation. I don’t think many of them necessarily want to speculate against the dollar but they at least want to protect themselves against its decline. My sense over the past month or so is that the tone may have changed to be more questioning of a continued dollar bear position than would have been the case perhaps a couple of months ago.
SB, Euromoney Vincent, what have you seen in the derivatives market?
VC, HSBC The dollar weakness theme definitely came back in earnest in the past three or four months. What is really interesting is the fact that Asia, which was not in play at all this year, came strongly into play in September and October and we witnessed a dramatic increase in volume in options-based strategies on Asian currencies. This was also true in the Brazilian real. Those positions were put on extremely aggressively and then in early October a lot of them were taken off. Right now the situation is very fluid but the key trend seems to be currency internationalization which, again, will undermine the dollar. Clearly, as the Chinese made extremely clear, they want the renminbi to become a currency that is used for trade settlement, at least in Asia; the Brazilians are interested in expanding their credibility and so are the Russians. I am not saying that the dollar is going to disappear as a reserve currency, but we are going to have more choice in terms of reserve currencies.
SB, Euromoney Paul, as a hedger what assumptions do you make?
PD, Shell Our primary product is denominated in dollars and we report and declare dividends in dollars. If investors are concerned about the dollar devaluing they can always form their own hedge portfolio. Longer term we assume a random walk in FX rates and don’t try to speculate on their movement.
DB, Deutsche There is a big difference between taking a view on the dollar against the G3 and trading dollar against the emerging market or commodity plays; these are two separate trades. If you are betting on China at the moment then you want to be long commodity currencies and short something; the natural thing is to be short the dollar. Japan is another issue; Japan cannot survive with the dollar/yen under 100 so you don’t want to be short the dollar against the yen. So it is key whether you are talking about being short the dollar against a G3 currency, or about the growth-type trades versus emerging markets.
