Washington impasse leaves FX investors 'chasing scraps'
The deadlock in Washington over the US budget has seen FX volumes drop sharply as investors stumble for direction.
Although most presume that a deal will be hammered out to ensure that the US does not default on its debt obligations, the government shutdown in Washington as president Barack Obama and his Republican opponents wrangle has not only affected the opening times of the country’s national parks.
It has also caused a delay in the publication of US economic data, adding another level of uncertainty to the effects of the impasse on the prospects for the US economy and the dollar.
“The day job is not made any easier by the dearth of top tier US data with which we would ideally judge the macro and policy outlook,” says Tom Levinson, FX strategist at ING Financial Markets.
Levinson adds that the job has been made harder by the fact that the government shutdown has also meant that FX market has been without weekly speculative positioning data for the dollar.
The US Commodities Futures Trading Commission releases widely watched speculative positioning data taken from activity on the Chicago Mercantile Exchange for the dollar against eight currencies each Friday. Those figures relate to activity up to the Tuesday of that week.
However, the US government shutdown has prevented the publication of that data for two weeks.
The last publication of the data, for the week to September 24, showed net long dollar positions had been cut to $3.6 billion. That came after speculators halved their net long positions from $22 billion to $11 billion in the week to September 17 as investors reacted to the Federal Reserve’s decision not to begin tapering its quantitative easing programme.
|CFTC speculative positioning versus US dollar up to September 24|
Levinson believes that it is likely that speculators have since flipped to short dollar positions. The absence of data makes it difficult to ascertain the scale of the move, however.
“Over the coming weeks, the dollar looks set to struggle,” Levinson says. “Both ourselves and the dollar are left feeding on scraps.”
Indeed, the US budget impasse and government shutdown have seen FX volumes decrease.
UBS, for example, says “not putting trades on” appeared to be the preferred expression of risk aversion sparked by the Washington deadlock last week, according to its client flow data.
The Swiss bank, the world’s fourth biggest FX bank according this year’s Euromoney poll, says volumes fell sharply and there was very little directionality in net client flows.
Dollar volumes collapsed to 77% of average, while flows in the euro and sterling were even weaker. Apart from the yen, the Australian and New Zealand dollars were the only currencies with gross flows above 80% of average, according to UBS.
Meanwhile JP Morgan says that after two weeks of stalemate there has been a plunge in FX market volumes. Activity has fallen to its lowest level in four years.
|October FX volumes the weakest in four years on some measures|
The lack of volatility engendered by the stalemate in Washington has extended the problems for currency investors who were already struggling to extract returns from the market.
The prospect of Fed tapering had already suppressed volatility in the currency market, limiting returns.
Indeed, CTAs have posted gains of just 0.34% so far this year from currency investing, according to calculations from BarclayHedge.
The difficulties encountered by FX fund managers have also been highlighted by the announcement of the closure of FX Concepts' main currency investment arm last week after 32 years in the business.
FX Concepts spent most of that time as the America’s largest FX hedge fund. However, Jonathan Clark, FX Concepts vice-chairman, says the company does not now have enough assets to sustain the business.
According to industry sources, FX Concepts’ assets under management dropped from a high of $14.7 billion in 2007 to just $620 million as it lost clients amid faltering returns.
The problem for currency investors has been that while volatility among G10 currencies has been subdued, and hence trading trends have failed to develop, because of a lack of monetary policy divergence among the world’s leading central banks, the sharp sell-off in higher-yielding emerging market currencies also destroyed returns from the carry trade investing over the summer.
The potential for consistent returns from carry trades – in which the purchase of high-yielding currencies is funded by selling low-yielding currencies – has long been cited as a reason to view FX as an asset class in its own right. Some analysts say the persistence of this phenomenon to produce returns over time produces a benchmark, or beta, for currency investing, which in turn attracts institutional investors to allocate funds towards currency investing.
From the perspective of carry trades, John Normand, global head of FX strategy at JPMorgan, offers a chink of hope to currency investors.
He says a consensus has formed that the standoff in Washington at least works for FX carry, since the fiscal debates limit any rise in US yields.
Normand warns that the yields on G10 carry baskets – due to monetary policy convergence – are near an all-time low, while EM carry – with a few exceptions – requires investing in currencies with little growth potential at the moment.
|Yield on a G10 FX carry basket near all-time low|
“G10 carry offers no value so is more a trade than an investment; and EM carry is risky given lack of growth momentum, so only worth a few positions,” says Normand.
He says he would love to diversify that restricted carry trade portfolio with a few momentum trades, but they do not tend to exist unless central bank policy is diverging across countries.
“For the next few months almost every central bank is on hold, and for the one that is easing – the Bank of Japan – the effect is already well discounted in the currency,” adds Normand.
It may well be that once the fog of the US budget debacle lifts, FX investors might have to wait a bit longer for directional clarity.