Too Much Volatility or Not Enough Derails Strategies: Currencies

Too much volatility for emerging-markets currencies -- and not enough in the developed world -- is stinging traders.

Increasing swings in exchange rates from Turkey to Hungary are wiping out profits in the carry trade, where investors buy higher-yielding assets funded by currencies with lower borrowing costs. Volatility in Group of Seven markets is receding as central banks hold interest rates at record lows and telegraph their next policy moves, confusing funds relying on trending movements for trading signals.

“It has been a double whammy,” Jon Stein, a managing director at Astor Janssen Partners, a financial advisor and consultancy, said in a telephone interview from Chicago March 19. “You cannot find trending opportunities among the G-10 currencies. And in the emerging markets, there’s still a lot of uncertainty. ”

Currency investors are suffering losses for a fourth consecutive year. Parker Global Strategies LLC’s Global Currency Managers Index, which tracks the performance of 14 funds it considers the elite in their class, is down 2 percent this year, extending its decline since the end of 2010 to 10 percent.

Harmonic Capital Partners LLP’s Alpha Plus Global Currency Fund lost 7.7 percent this year through February, following a 18 percent drop in 2013, according to Fairfield, Iowa-based BarclayHedge, which tracks fund performance. GAM UK Ltd.’s currency fund has declined 17 percent over the past year, while trading losses caused FX Concepts LLC, once the world’s biggest currency hedge fund, to file for bankruptcy protection in October.

Volatility Divide

Emerging markets have been roiled since the end of last year as the Federal Reserve began to scale back stimulus, while economic growth has slowed in China. A gauge of anticipated developing-nation currency volatility is 1.7 percentage points more than for the world’s industrialized economies, a turnaround from last year, when it averaged 0.5 percentage point less. Implied volatility on Turkey’s lira has more than doubled during the past 10 months.

Buying a basket of five highest-yielding emerging-market currencies, including India’s rupee, the lira, Brazil’s real, South Africa’s rand and Russia’s ruble, with funds borrowed from lowest-yielding currencies, such as the yen and Swiss franc, has lost 2.8 percent this year, according to data compiled by Bloomberg.

‘Nasty Market’

“It’s been a bit of a nasty market for almost any kind of philosophy,” Eric Busay, currency and international fixed-income money manager in Sacramento at California Public Employees’ Retirement System, the largest U.S. public pension, with $277 billion in assets, said in a telephone interview March 20. “The market is dominated by monetary policy on a global basis.”

Alastair Smith, a partner at Harmonic Capital, which oversees $948 million in assets, said in an e-mail that their currency fund’s loss was “a result of recent volatility in the currency markets.”

GAM’s $86 million currency fund has declined 3.2 percent this year through March 18, following 5.4 percent losses in 2013, data compiled by Bloomberg show. Adrian Owens, who runs the GAM fund, said his bullish bets on the U.S. dollar, Mexican peso and Norwegian krone contributed to the fund’s losses.

While it has been a “difficult” period, Owens said via e-mail he sticks to his bets, saying the dollar and peso have the “potential to really fly” as the U.S. economy improves.

Dollar Measure

Measures of the pace of movements in the Bloomberg Dollar Spot Index, which tracks the greenback against 10 of its major counterparts, reached the lowest since July 2007 on March 18.

As volatility has waned, so has currency turnover. Average daily trading on ICAP Plc’s EBS electronic platform tumbled 44 percent in February from a year earlier to $84 billion, and compared with an average $116 billion last year, according to the world’s largest interbank broker.

Foreign-exchange trading revenue at U.S. commercial banks was $499 million in in the third quarter of 2013 compared with $3.14 billion in the prior quarter and $890 million in the three-month period a year earlier, according to the latest data available from the Comptroller of the Currency.

The dollar strengthened last week as Fed officials, following a two-day policy meeting, signaled that short-term rates may rise faster than previously projected. The U.S. central bank has held its benchmark interest-rate target at virtually zero since 2008. Fed policy makers also reduced monthly bond-buying by $10 billion, the third consecutive cut of that size.

Europe, Japan

The European Central Bank held its key interest rate at a record low 0.25 percent on March 6 as it works to help the region’s economy recover from the financial crisis. The Bank of Japan retained on March 10 its pledge to expand the monetary base by 60 trillion ($587 billion) to 70 trillion yen per year as part of policy supported by Prime Minister Shinzo Abe to end two decades of deflation.

Some companies have made money trading currencies this year. The $1.5 billion John Hancock Funds II Absolute Return Currency Fund gained 3.7 percent this year, extending its return during the past year to 7.4 percent. About two-thirds of its bets this year have been profitable, including those on the decline of the Canadian dollar and the rise of the yen, according to Dori Levanoni, a partner at First Quadrant LP/USA in Pasadena, California, which manages the fund.

Market Response

“The issues are temporary and already waning,” said Levanoni, who helps manage $8.7 billion currency assets at First Quadrant, in a telephone interview on March 20. “Markets do appear to be responding to fundamentals as they would normally do, rather than swung around in a risk-on, risk-off fashion.”

Emerging markets have been rocked in recent months amid signs that China’s economy is slowing just as the Fed pares its stimulus and tensions between Russia and the U.S. rise over the fate of Ukraine. Central banks from Turkey to South Africa fought back by raising interest rates to stem currency losses, which fuel inflation and capital flight.

The Bloomberg custom index of the 20 most-traded emerging market currencies fell to a five-year low on Feb. 3 before rebounding about 2 percent.

Turkey’s currency tumbled a record low of 2.39 per dollar on Jan. 27, rose 2.3 percent the following month, only to decline 1.5 percent in March. It was at 2.2258 at 12:51 a.m. in New York. Hungary’s forint reached its low for the year on Feb. 3, at 232.87 per dollar, before gaining to 225.94 today.

Trading Strategy

“You have to be careful now with not so much what currency you buy, but the one you sell, the funding currency to use,” said Peter Kinsella, a foreign-exchange strategist at Commerzbank AG in London, during a telephone interview March 21.

An ideal strategy would be to purchase the real, after Brazil’s central bank lifted its benchmark rate to 10.75 percent in February, through loans denominated in yen, Kinsella said.

Unlike the 1997 Asian financial crisis, when currencies plunged for months before roaring back, the recent emerging-market currency moves are slower and choppier, making it difficult for investors to place or hold onto their bets, according to Bhanu Baweja, the head of emerging-market cross-asset strategy at UBS AG in London.

“This is a slow-burning market,” Baweja said in a telephone interview March 7. “It’s two steps forward, three steps back. Investors are not used to that. They’ve got chopped around. It’s quite painful.”

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