June 16, 2009
Posted by: Dave Bhagat
When you come to a fork in the road, take it.
Until Monday's rally, the dollar was range-bound versus the
EUR and JPY in a fairly narrow band. Even after yesterday's move,
the near-term ranges remain relatively narrow - 1.35 to 1.4350 for
the EUR and 94 to 100 for the JPY. While these ranges will not hold
forever, there are no compelling reasons for them to break in the
near term, nor a clear sense of which direction the break will
occur. As a result, currency volatility has fallen slightly.
Historically, lower currency volatility and increased risk appetite
have resulted in a pick up in carry trades. That is not as likely
in today's environment because even though volatility has fallen,
it is still relatively high compared to recent years. More
importantly, risk appetite is down significantly from what it was
before the housing and financial crises hit us - capital
preservation still gets the nod over speculation.
When and if carry trades make a comeback, there is a third
currency to add to the list of "funding" currencies in addition to
the JPY and CHF: the dollar. Like the JPY and CHF, rates are low
and are unlikely to rise rapidly, despite falling bond prices and
rising long-term yields. That is a potential drag on the dollar
down the road. I do not believe the Federal Reserve is done with
quantitative easing. Despite all the recent optimism about a
recovery, I think it will take several quarters to unfold and will
be tepid at best. I believe as long as inflation remains
nonexistent (it will, for several quarters) and as long
unemployment keeps rising and demand remains weak (at least until
the middle of next year), the Fed will keep Fed funds on hold and
keep a lid on market yields through bond purchases in the market.
Low short-term rates, a weak economic recovery, capital flows
turning increasingly dollar-negative and longer-term inflation
concerns are a good breeding ground for short dollar/long other
currency carry trades for the next year or more. The trick is to
identify the currencies that will outperform.
I believe we are at the beginning of a trend that will see a
significant, long-term outperformance of undervalued, higher growth
emerging market currencies at the expense of some of the major
currencies. The dollar will lag and probably the EUR and JPY as
well on concerns about a weak recovery and low rates. The EUR is
somewhat overvalued as well, while the Japanese economy continues
to languish and flows are still not supportive. The GBP has done
well of late, as it was oversold and an economic recovery seems
closer at hand, but concerns about mounting deficits and a
sovereign downgrade will limit further gains. Finally, the Canadian
and Australian economies appear stronger and have better prospects,
but both currencies have anticipated that and offer limited value
from current levels.
Getting back to my initial thought, I believe most major
currencies will trade in narrow ranges for the next few months in
the absence of significant new information. As long as we face the
prospect of a slow, painful global recovery with the U.S. and
Europe lagging, emerging market currencies such as the CNY, INR,
BRL and others will grind their way higher at the expense of the
In my opinion, the dollar can only rally meaningfully if one of
two things occurs: another significant meltdown - which results in
a panic-induced flow back into treasuries and the dollar - or a
dramatic upturn in our economic fortunes. Anything in between
should result in further erosion of our currency. The reasons given
will include carry trades, concerns about our deficits, concerns
about future inflation, concerns about the dollar's reserve status
and concerns about capital outflows. The truth is the dollar will
probably fall because there are more attractive investment
alternatives elsewhere for the reasons above and more.
For now, major currencies are relatively stable because flows are
balanced and the market is somewhat confused about how the global
recovery will play out. As we approach the fourth quarter, I
believe optimism about a strong, quick recovery will fade and that
is when we will see the bulk of the dollar's decline versus the
emerging market world. Predicting what happens among the major
currencies is more difficult; it depends on where they are at the
time, what has been priced in and how the flows play out.
The behavior of equity markets will play in a role in this
process. Currently, equities are struggling to advance further in
most regions except Asia, weighed down by surging commodity prices,
soaring bond yields and a perception they have gone up too far and
too quickly. If I am right and growth and inflation expectations
are ratcheted down in Q4, this will provide a more favorable
backdrop for equities, but only in those markets where growth
expectations remains alive and well. I believe that is when we will
see another wave of outflows from developed markets into the better
performing emerging markets, and it is this capital movement that
will be the catalyst for further emerging currency gains.
There could be an opportunity here. Volatility (and therefore the
prices of options) is high for most major currency pairs, but I
expect the currencies themselves to remain relatively stable.
Volatility remains cheap for most of the larger emerging market
currencies, however. Companies that need to hedge major currency
exposures can use this period of relative stability to lock in
hedges through the forward markets. Both forward and option hedges
look attractive for hedging emerging market payables given
relatively "cheap" pricing, especially if events unfold the way I
believe they will. Summers are all too short and forks in the road
fly by. Not all forks in the road are worth taking - perhaps just
those that protect emerging market payables...
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Summer Doldrums Already?October 22, 2012 Posted by: Dave Bhagat
When you come to a fork in the road, take it.
Until Monday's rally, the dollar was range-bound versus theEUR and JPY in a fairly narrow band. Even after yesterday's move,the near-term ranges remain relatively narrow - 1.35 to 1.4350 forthe EUR and 94 to 100 for the JPY. While these ranges will not holdforever, there are no compelling reasons for them to break in thenear term, nor a clear sense of which direction the break willoccur. As a result, currency volatility has fallen slightly.Historically, lower currency volatility and increased risk appetitehave resulted in a pick up in carry trades. That is not as likelyin today's environment because even though volatility has fallen,it is still relatively high compared to recent years. Moreimportantly, risk appetite is down significantly from what it wasbefore the housing and financial crises hit us - capitalpreservation still gets the nod over speculation.
When and if carry trades make a comeback, there is a thirdcurrency to add to the list of "funding" currencies in addition tothe JPY and CHF: the dollar. Like the JPY and CHF, rates are lowand are unlikely to rise rapidly, despite falling...Read More