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Trade Stock-Neutral Currencies to Avoid Risk Swings, RBC Says

Foreign-exchange investors looking to avoid sharp swings in risk should focus on currency trades whose values don’t hinge on stock-market performance, according to Royal Bank of Canada.

Currency pairs that include the Norwegian krone-Swedish krona and the New Zealand dollar-Norwegian krone have “statistically insignificant” correlations with the daily returns of the Standard & Poor’s 500 Index, Adam Cole, the bank’s head of global currency strategy in London, wrote in a note to clients issued July 16.

“The past month alone has seen the S&P trade in a massive 11 percent high-to-low range -- double the long-term average -- yet the net change over the same period is almost exactly zero,” Cole wrote. “We stand aside from predicting whether the trading environment is risk-on or risk-off on a daily basis.”

Norway’s krone fell 0.2 percent versus the Swedish currency today to 1.1676 krona. New Zealand’s dollar weakened 0.4 percent against the Norwegian currency.

Trades that involve commodity-linked currencies, such as the Canadian and New Zealand dollars, and Scandinavian currencies, including the krona and krone, have been the most stock-neutral, Cole said. These currencies also encompass countries where central banks first raised interest rates, Cole said.

“Because they have quite similar characteristics in riskiness, they tend to cancel each other out in terms of risk,” Cole said today in a phone interview.

Trading currencies with high liquidity, including the U.S. dollar and Japanese yen, is “impossible without taking a view on risk appetite,” he said.

‘Stock-Neutral Window’

RBC’s “stock-neutral window,” which now includes nine currency pairs, should widen as the economic recovery stabilizes, according to Cole.

“When we were in the early stages of the recovery, the window started to get a lot wider,” Cole said. “It’s only started to narrow as people have called into question the durability of the recovery.”

Other pairs in the window are the New Zealand dollar- Canadian dollar, the euro-pound, the New Zealand dollar-krona, the Canadian dollar-krona, the pound-franc, the Canadian dollar-krone and the euro-franc.

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