Will 2013 be the year of foreign exchange?
Macro hedge funds back with a vengeance; return to trading on fundamentals.
FX dealers have recaptured their mojo. Hopes for US economic recovery and Japanese adoption of radical quantitative easing are weakening the yen against the dollar and have provided a big theme to re-engage with for many market participants that sat on the sidelines last year. Macro hedge funds have been back with a vengeance, eager to get in front of a big move that some commentators have been calling since late 2012. Jeff Feig, global head of G10 FX at Citi, says: “The first quarter in particular was a hedge fund fest. Our dollar/yen volumes had previously fallen to a mid-teen percentage of our total business, but that returned in the first quarter of this year to account for over 30% of our volume, much more consistent with the size and importance of the Japanese economy.”
Feig’s colleague, James Bindler, CEEMEA forex trading head and global head of FX options, adds: “For the best part of a decade we had grown used to seeing the big macro hedge funds moving out of the major markets and into the emerging markets. In the past six months, we’ve seen the big emerging market-based funds crossing over into G10 currencies and doing very big volumes, which has been very exciting for us.”
The market is not firing on all cylinders just yet. Most FX dealers report that, even with the big move in dollar-yen and weakness in sterling against the dollar, corporates that do a lot of importing or exporting and that typically have board-approved programmes to hedge between 50% and 80% of currency exposure in any given year have not yet rushed to adjust their long-term hedges. These trends might need to become more firmly established before corporates become more active.
Bank equity analysts at Citi suggest that spot FX volumes in the first quarter of 2013 were 51% ahead of the final quarter of 2012 and close to 20% ahead of the first quarter of 2012, while FX derivatives volumes were up by close to 25% in the first quarter this year, compared with the first quarter in 2012, as volatility returned to the FX market. Some of that gain will have been offset by a slight decline in bid-offers, but it’s been an unexpectedly swift and very welcome revival.
“From the start of this year, we’ve seen a return to trading currency more on fundamentals, with signs of more normal correlations and volatilities,” says Kevin Rodgers, global head of FX at Deutsche Bank. “The key long-term trend conditions for the foreign exchange business to remain in a growth phase, including cross-border holding of assets and capital flows, remain in place.”
Dealers are even talking once more about FX as an asset class, a deeply liquid and busily traded financial market where expert managers can provide alpha to long-term investors such as pension funds that is not correlated to either equity or bond markets.
It’s not a new idea. All this was the subject of much excited discussion 10 years ago in the wake of the first three-year losing equity market run after the bursting of the dot-com bubble. Investment consultants spent much time and effort examining the three-, five- and 10-year records of currency specialists, tracking their funds’ Sharpe ratios, information ratios and the correlation of returns to other large asset classes.
Then the great leverage bubble took hold and drove up conventional financial assets, real estate, private equity and just about everything else – so enthusiasm for the more complex world of FX, where currencies perform only against each other rather than as carriers of intrinsic value, waned.
Now the FX market’s time may be coming around again.
With rates low, truly safe-haven government bond markets expensive, many credit assets having rallied and equities also looking to many market participants over-bought in expectation of a recovery that might not be coming, investors are once again searching for alpha in a low-return world and thinking about currencies.
|Andrew Millward, of Morgan Stanley|
Andrew Millward, head of FXEM trading Ceemea at Morgan Stanley, says: “It could well be that 2013 is going to be the year of foreign exchange. Since 2008, FX has been highly correlated between risk-on and risk-off currencies. But now those correlations are breaking down. Major currencies like yen and sterling, that were once safe havens, are right in play for the macro hedge fund community. The dollar is no longer a funding currency: it’s an asset currency. Beyond that, greater diversification is also coming to the emerging market currencies where some countries now see their current accounts deteriorating while others with strong structural reforms in progress are performing well. “The good news is that financial markets absorbed concerns around Cyprus without panic and want to put money to work. And while the big story is dollar strength and yen weakness, there’s plenty more to do beyond that pair and just going short sterling and euro against the dollar. There’s an emerging market reflation story going on as well, and because of this we are currently advising clients to go long Mexico and Poland, for example.”
George Athanasopoulos, co-head of foreign exchange at UBS, says: “We certainly see more clients in the institutional asset manager space, not just hedge funds, trying to extract alpha in foreign exchange right now, as well as investors from other asset classes focused on currency, including equity and credit funds that saw asset correlations increase during the financial crisis of the past few years. Those investors now see the highly liquid and non-correlated currency markets as a useful proxy hedge.”