Rand, Won Insurance Costs Soar as Japan Radiation Risk Threatens Expansion
The cost to insure against declines in South Korea’s won and South Africa’s rand surged as concern mounts that a nuclear disaster in Japan and conflict in the Middle East will derail the global economic expansion.
One-month options giving investors the right to sell the rand cost 2.41 percentage points more than contracts to buy the currency, compared with 2 percentage points yesterday, the biggest increase since April, according to data compiled by Bloomberg. The premium to sell the won rose to 3.69 percentage points from 2.93, the biggest surge since November.
Emerging-market currencies plunged today, led by a 2.5 percent drop in the rand, as Saudi Arabian troops arrived in Bahrain and Japanese Prime Minister Naoto Kan said the danger of further radiation leaks was rising at a crippled nuclear facility 135 miles (220 kilometers) north of Tokyo. Implied volatility on currency options in developing nations jumped the most since May, according to data compiled by JPMorgan Chase & Co.
“You have a lot of cross winds and cross currents,” said Amit Tanna, who oversees about $8 billion in London at JPMorgan Asset Management. “Quite a lot of things are coming to hit the market. Why not buy some insurance?”
Tanna said he bought option contracts to protect against the drop in currencies including the Mexican and Chilean pesos.
Mexico’s peso slid 1.1 percent, the most since January, to 12.0307 per dollar at 1:36 p.m. New York time, after reaching the strongest level since October 2008 yesterday. The Chilean currency lost 0.5 percent versus the dollar, while Russia’s ruble dropped 0.9 percent, the most since November.
JPMorgan’s Emerging Market Volatility Index, which reflects investor expectations of currency swings in the future, jumped to 10.6 percent from 10.1 percent, the most since November. Traders use implied volatility to set option prices. In option contracts, investors pay a premium in exchange for the right to buy or sell a currency at pre-agreed prices. The lower the volatility, the lower the premium.
Before the selloff this week, swings in emerging-market currencies were declining as the global economy recovered from the 2008 financial crisis. JPMorgan’s volatility index declined to 9.89 percent on March 10, the lowest level in 11 months.
The last time implied volatility dropped below 10 percent, in April 2010, emerging-market currencies tumbled 4.4 percent in the following month. A previous dip during 2006 and 2007 foreshadowed the global financial crisis in 2008.
The Japanese shares sank 10.6 percent today, capping the biggest two-day drop since 1987, while bonds jumped globally, on concern two explosions that damaged Tokyo Electric Power Co.’s nuclear power plant will cause more radiation leaks in the wake of last week’s earthquake. In the Middle East, Saudi Arabian troops moved into Bahrain with a regional force in the first cross-border military intervention since the uprisings across the region toppled Egyptian President Hosni Mubarak last month.
Brazil’s real is among the most “vulnerable” currencies as Japanese investors may repatriate funds to rebuild the country, according to HSBC Holdings Plc. Japanese mutual funds held 2.8 trillion yen ($34.6 billion) of Brazilian stocks and bonds as of the end of last month, the fourth most foreign- currency assets after the U.S., Australia and Europe, according to data from Japan’s Investment Trust Association.
UBS AG has advised its clients since February to buy options to protect against declines in the won and the Indian rupee as a surge in oil prices this year weakens the economies of the Asian energy-importing nations.
“It’s cheap to buy emerging-market protection,” said Manik Narain, an emerging-market currency strategist for UBS in London. “There’re more signs now that global growth momentum” may be slowing, he said.
It costs about $26,700 to buy $1 million worth of three- month put options for the won with a strike price at the forward rate, 12 percent cheaper than at the end of 2010, according to data compiled by Bloomberg. Put contracts give investors the rights to sell the currency. Similar put options for the rupee cost $20,700, a 12 percent reduction from Dec. 31.
State Street Global Advisors has reduced its exposure to emerging market currencies and remains “cautious” toward countries with large current account deficits, including Turkey, said Collin Crownover, the Boston-based head of currency management at the company, which oversees $95 billion in assets. The Turkish lira has lost 9 percent versus the euro in the past three months, the worst performer among developing countries, as the political turmoil in the Middle East spreads and the oil spike widens Turkey’s record current account deficit.
“It’s a reasonable time to buy protection,” said Crownover. “I would expect currency volatility will catch up.”
The lira, rand, Brazil’s real and the Polish zloty will “underperform” because the currencies are either overvalued or rely too much on foreign funding, according to Goldman Sachs Group Inc. The New York-based bank is recommending its clients bet the lira will fall against the euro, “targeting” a further fall of 5.7 percent to 2.35 per euro.
Maxime Tessier, a portfolio manager in Montreal at Caisse de Depot et Placement du Quebec, said emerging-market currencies in Latin America and Asia will rally as the economies are strong enough to overcome higher oil prices and central banks are able to defeat inflation.
“Investors are cautiously optimistic,” said Tessier. His company, Canada’s biggest pension fund manager, oversees C$152 billion ($154.8 billion) in assets.
JPMorgan’s volatility index fell to a record low of 5.8 percent in July 2007 as investors gained confidence in developing nations after Mexico’s debt default in 1982 and the Asian financial crisis in 1997 and 1998. Policy makers’ efforts to reduce debt and curb inflation have made their interest-rate and currency moves more predictable.
The index began rising when credit markets froze late in 2007, and hit a record 35.8 percent in October 2008, one month after Lehman Brothers Holdings Inc. collapsed. It has since dropped by two-thirds as the global recovery takes hold.
“There’s plenty of risk out there,” said Paul Mackel, a currency strategist at HSBC Holdings in London, who co-wrote a research note titled “FX Markets: Calm now, storm later” on Feb. 21. “Investors should be considering buying some potential insurance.”
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