After the blast of sharp risk reduction a couple of weeks ago, there has been a
cautious reemergence of risk appetite by global investors in the commodity
complex of AUD, NZD, CAD, NOK for currencies and with a little taste of gold on
the side for "good luck." The reason for paying attention to this group of
currencies is it tends to be a bellwether for rapid flows away from EUR and USD
in times of high volatility and shows correlation to short-term ranges for the
two major currencies. By paying attention to this side activity could provide
insights into key ranges for the EURUSD.
The AUD typically leads the pack
as it has been whipsawed over the past couple of months with EURUSD falling off
the cliff. AUDJPY has been the tip of this sword and is best indicator of
volatility. Starting on March 1, AUDJPY hit 79.85, its 200-day moving average at
the time, and did not look back peaking at 87.96 on May 4 (about a 10 percent
increase in 63 days). From March 1 to May 4, the EURUSD 50-day moving average
began a steady 1.5 percent per month slide. During the same period,
fundamentally, there was the brewing Greek debt situation, Spain's own debt
issuance issues, and the realization of investors worldwide that European debt
was simply unsustainable. As a result, we saw EURUSD move from 1.3665 to 1.2982,
a 5 percent drop. So for those who had EURUSD receivables, this could have been
a time to begin pondering risk mitigation as a result of risk premium reduction
to the USD. By looking at a rapid AUDJPY rise, and the fundamental pressure on
the euro zone and EUR, we could reasonably conclude that a drop in EUR was
forthcoming.
In a more detailed review, there is even further evidence of
correlation. The proverbial stone in the pond begins with AUDJPY falling prey to
heavy and rapid risk reduction or a reversal of the uptrend starting on March 1.
On May 6, AUDJPY began the day at 85.01, fell to 77.04 and closed at 80.18. Over
the next two weeks, it broke a major technical support line at 76.20 and
continues its slide, finding some footing now around 76.50. In addition, a less
liquid cross, though still meaningful, is the sharp decline in AUDCAD from a
high of 94.40 on May 6 to a low of .8651 on May 21, of which AUDJPY fell to a
low of 71.90 which corresponds to a major technical level.
On May 6
through May 13, AUDJPY saw a modest increase of about 3.9 percent. During the
same time, EURUSD fell from 1.2814 to a low of 1.2142 (or a 9.5 percent drop)
where it seems that central banks have been lurking in support of the EUR. Once
1.2142 bottom was reached on May 18, from then until May 21 we saw upside tests
of 1.2672. In the meanwhile, AUDJPY backed off from a high of 81.65 to a low of
71.90, indicating a period of major short covering on the EURUSD and selling of
AUDJPY to help fund this activity. In these extreme periods of flow reversal, we
note that an AUDJPY and AUDCAD correction can correlate to the timing of an
upward correction in EURUSD and magnitude in very short trading timeframes of
hours and days.
To showcase the impact of these moves, one of our clients
(call it Company Z) began pricing a risk reversal (a no cost currency option
strategy that allows the company to establish a range of currency exchange rate
hedging EUR receivables for a future date). Of course, the astute SVB FX Advisor
noted the storm going on with AUDJPY and AUDCAD beginning to lose its risk
attractiveness. This indicated a potential short-term signal for a reversal in
the EURUSD slide and represents an opportunity for Company Z, which is adamant
about hedging its receivables despite the "storm." The price of the strategy
during the EURUSD reversal moved to a favorable range of 1.2345 to 1.2876 early
in the day. However, the client did not act, believing that more upside was
available. Two hours later, the same priced strategy moved to a range of 1.1850
to 1.2345. On a million dollars worth of currency protection, that equated to an
opportunity loss of about 97K. Luckily, this fell within the company's threshold
for its hedging rates for the year — the lowest case scenario — the risk
tolerance was met.
So what does all this technical mumbo jumbo mean for
our customers? DO NOT TRY TO PRICE YOUR KEY STRATEGIES DURING A STORM! While
that might not be meaningful to our clients who are far more concerned about
their R&D, product introductions, revenue generation and expense reductions,
following these two pairs might provide enough of a crystal ball that you should
start taking a hard look at your functional currency hedging for your major
exposures.
A final point is whether this means the commodity currency
complex is a currency "fortune teller?" Of course not, or we'd all be endlessly
wealthy. However, as a signal-based risk reduction tool, watching AUD against
the JPY, CAD and USD could act as the catalyst to prompt our clients to begin
earlier-than-expected currency exposure analysis. To reiterate, the second
lesson learned is that implementing long-term hedging strategies in the middle
of volatile intraday movements can be managed, but it requires very decisive
action and having a benchmark set of rates with which to guide decisions.
The views expressed in this column are solely
those of the author and do not reflect the views of SVB Financial Group,
or Silicon Valley Bank, or any of its affiliates. This material,
including without limitation the statistical information herein, is
provided for informational purposes only. The material is based in part
upon information from third-party sources that we believe to be
reliable, but which has not been independently verified by us and, as
such, we do not represent that the information is accurate or complete.
The information should not be viewed as tax, investment, legal or other
advice nor is it to be relied on in making an investment or other
decisions. You should obtain relevant and specific professional advice
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and losses may occur in short periods of time if there is an adverse
movement of exchange rates. Exchange rates can be highly volatile and
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as supply and demand and governmental intervention, control and
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