Risky Business

VO­LATIL­ITY IN THE FOR­EIGN EX­CHANGE MAR­KET HAS SPIKED, LEAV­ING IN­VESTORS AT A CROSS­ROADS. MICHAEL HOARE LOOKS AT WHETHER THEY SHOULD HUNT FOR OP­POR­TU­NI­TIES OR SEEK SAFETY

Hong Kong Tatler - - Working The Land -

The will-they-or-won’t-they guess­ing game on in­ter­est-rate hikes has ush­ered in the type of vo­latil­ity in for­eign ex­change mar­kets that has sel­dom been seen this year. While that’s good news for cur­rency traders watch­ing the mar­ket and mak­ing moves by the nanosec­ond, it’s po­ten­tially bad news for your port­fo­lio. Ear­lier this year, the JP Mor­gan G7 Vo­latil­ity In­dex fell to its low­est level in two years. The in­dex, which tracks fluc­tu­a­tions in the world’s ma­jor cur­ren­cies, was be­calmed. How­ever, in Septem­ber, the bank’s for­eign-ex­change strate­gist John Nor­mand de­clared vo­latil­ity was back, although at a level be­low what pro­fes­sion­als may con­sider “healthy”.

David Kohl, head of cur­rency re­search at Julius Baer in Frankfurt, agrees with this anal­y­sis. “After a pe­riod that I would de­scribe as be­ing very quiet, where there’s been no one trad­ing, we’re now start­ing to get to the stage when we see op­por­tu­ni­ties be­gin to ap­pear,” he says. A Swiss-based pri­vate bank, Julius Baer has branches in more than 25 coun­tries and re­gions in­clud­ing Hong Kong as well as a rep­re­sen­ta­tive of­fice in main­land China.

Kohl says the re­cent spike in forex ac­tiv­ity and vol­ume of trans­ac­tions has come as a “con­sen­sus call” has emerged on the US dol­lar. Mixed eco­nomic data has fash­ioned a di­ver­gence in mon­e­tary pol­icy, which in turn has cre­ated an im­bal­ance in mar­kets. The dol­lar has ap­pre­ci­ated by more than 5 per cent against ma­jor cur­ren­cies so far this year.

Safety first

Teck Leng Tan is a forex an­a­lyst at the UBS Chief In­vest­ment Of­fice’s Wealth Man­age­ment sec­tion. He is keep­ing an eye out for De­cem­ber’s guid­ance from the United States Fed­eral Re­serve. In that bulletin, he ex­pects the cen­tral bank’s chair­woman Janet Yellen to of­fer a clearer vi­sion for the wind­ing down of Amer­ica’s loose mon­e­tary pol­icy regime, oth­er­wise known as quan­ti­ta­tive eas­ing. “Clearer guid­ance of the Fed’s rate hike tim­ing is likely to re­in­force our house view for a broadly stronger US dol­lar,” he says.

About US$5 tril­lion in cur­rency trades flow around the globe each day, in a non-stop bal­let of bid and ask that moves at light­ning speed. In­vestors like the sys­tem for its ef­fi­ciency

and rel­a­tive trans­parency, and there is that vast pool of liq­uid­ity to tap – some of which will evap­o­rate as in­ter­est rates climb.

With both the Fed­eral Re­serve and the Bank of Eng­land “vis­i­bly shift­ing away” from the poli­cies that have flooded mar­kets with bil­lions of dol­lars and kept in­ter­est rates low, Tan sees the US dol­lar and Bri­tish pound ap­pre­ci­at­ing in the next three to six months.

“We ex­pect th­ese two cen­tral banks to raise pol­icy rates ear­lier than other ma­jor cen­tral banks, which points to fur­ther gains in th­ese cur­ren­cies, es­pe­cially ver­sus the Euro and Swiss franc,” he says.

UBS forecasts that Bri­tain will hike in­ter­est rates this Novem­ber. In Amer­ica, rates are likely to rise some­time in the mid­dle of next year.

Trip­ping point

One of the speed humps to sus­tained growth is the main­land’s eco­nomic health. In late Septem­ber, the Gold­man Sachs Group joined the pre­vail­ing con­sen­sus among the in­vest­ment houses that eco­nomic growth over the bor­der will con­tinue de­clin­ing in the next two years.

It has fore­cast 7.16 per cent growth next year – down from a prior es­ti­mate of 7.6 per cent – that will shrink to about 6.7 per­cent in 2016. Like­wise, UBS ex­pects growth in gross do­mes­tic prod­uct to shrink next year. It has fore­cast GDP growth of 6.8 per cent.

The slow­down’s ef­fect will be most sharply ex­pe­ri­enced by the main­land’s big­gest sup­pli­ers of com­modi­ties, par­tic­u­larly Aus­tralia and In­done­sia.

A re­port pub­lished in Septem­ber by Roubini Global Eco­nomics, the re­search house set up by Nouriel Roubini – a man known for his bear­ish forecasts – sees the Aus­tralian dol­lar slid­ing by about 20 per cent against the US dol­lar.

While main­land China’s growth slow­down has Aus­tralian min­ers see­ing red, there are other cur­rency pit­falls to be wary of, loom­ing just beyond the hori­zon.

Avoid euro, yen?

With the Eu­ro­zone coun­tries re­turn­ing con­sis­tently dis­ap­point­ing eco­nomic growth data, there is an on­go­ing ar­gu­ment there for a greater slack­en­ing of mon­e­tary pol­icy. And the sit­u­a­tion is sim­i­lar in Ja­pan, where GDP col­lapsed in the sec­ond quar­ter. The an­nu­alised con­trac­tion for Ja­pan’s econ­omy was 7.1 per cent – the fastest pace since 2009. The third most traded cur­rency, the yen, has re­acted ac­cord­ingly, flag­ging against the US dol­lar.

“Economies in the Eu­ro­zone and in Ja­pan are los­ing mo­men­tum, and there is a bias for fur­ther mon­e­tary eas­ing,” says Tan. “We’d ad­vise avoid­ing the euro and yen, as fur­ther quan­ti­ta­tive eas­ing will neg­a­tively af­fect the value of th­ese cur­ren­cies.” Avoid the Swiss franc too, he says.

But Kohl points out that poor eco­nomic data tends to be a “short-term driver of cur­rency ex­change rates”. Over a longer time frame of six to 12 months, hold­ing the yen or the euro might be a sound strat­egy. “Th­ese cur­ren­cies will not be af­fected by the data com­ing up next month, not now, not next week but in ex­actly the next six to 12 months,” he says.

Of course, where there’s risk, there’s re­ward, es­pe­cially for in­vestors with an eye to hold­ing Asian cur­ren­cies through to next year. If you have the stom­ach for risk, the Philip­pine peso and In­dian ru­pee of­fer po­ten­tially at­trac­tive re­turns, ac­cord­ing to Tan.

“While th­ese cur­ren­cies are less liq­uid, which ex­plains their higher vo­latil­ity, we be­lieve an on­go­ing tight­en­ing cy­cle by the Philip­pines cen­tral bank (Bangko Sen­tral ng Pilip­inas) should trans­late into a mod­er­ate ap­pre­ci­a­tion of the peso,” says Tan.

Also worth a look is the “frag­ile five” favourite – In­dia. The ru­pee is a favourite for cur­rency carry trades, where in­vestors sell short one cur­rency to take a po­si­tion in another de­nom­i­na­tion yield­ing a higher in­ter­est rate. When lever­aged, th­ese deals can have tremen­dous pay­offs. In the ru­pee’s case, UBS pre­dicts a high-yield carry of be­tween 6 per cent and 7 per cent.

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