Currencies funds feel strain of US deadlock

Last updated: October 14, 2013 8:21 pm

Currencies funds feel strain of US deadlock

By Delphine Strauss

Currencies traders do not know which way to turn. This was meant to be the year the dollar would come roaring back against other major currencies, as the US recovery picked up steam and the Federal Reserve began scaling back its vast stimulus programme. After years of near-zero interest rates in most developed economies, hedge fundswere hoping that divergent central bank policies would finally create clear-cut economic trends on which to trade.Instead, they face an acute dilemma, as the deadlock in US debt talks drags on. The government shutdown will take its toll on the US economy and makes the Fed more likely to delay a tapering of asset purchases until next year – delaying dollar appreciation. Yet, as the deadline to raise the debt ceiling approaches, could investors pour yet more money into the dollar as the ultimate haven?

For now, many are avoiding placing any bets at all. A measure of volatility in major currencies has tumbled to its lowest level since January, despite a rise in the Vix equity “fear” gauge. The dollar has weakened, but not by much – it has slipped just 0.3 per cent against the euro since the shutdown began and only 1.1 per cent in a month against the yen, the favoured haven.

Analysts at JPMorgan say that, on some measures, forex trading volumes in October are the weakest in four years. Weekly data on speculators’ forex positions is unavailable, thanks to the US shutdown, but Morgan Stanley estimates that its clients’ positions now equate to a neutral stance on almost all major currencies.

“It’s been one of the quietest quarters on record. Volatility has been very low, it’s been the tightest range in euro-dollar in its history,” says Kevin Rodgers, global head of foreign exchange at Deutsche Bank.

The stand-off in Washington has exacerbated confusion over the likely trajectory of US monetary policy, with investors already shaken by September’s unexpected decision to delay tapering.

“The Fed caught the market completely on the hop. Now it doesn’t really know what to do,” Mr Rodgers says. “Until these things get sorted out, it’s difficult for risk capital to deploy itself one way or another.”

But the autumn lull reflects a deeper malaise in forex markets. It follows a long period of “risk on, risk off” trading that has been especially painful for “systematic” hedge funds. Such funds trade using quantitative models, and prosper when divergence in monetary policies creates opportunities to buy high-yielding currencies, in so-called “carry” trades, or ride long-running appreciation and depreciation trends.

FX Concepts, once one of the biggest such funds, with $14bn under management in 2007, said last week it was winding down its investment management business after losing a string of big clients.

“Systematic funds are built on carry and momentum, and you have neither now because of the monetary policy distortions of quantitative easing,” says Stephen Jen, head of the currency hedge fund SLJ Macro. “Unless interest rates are allowed to reflect fundamentals . . . these models will continue to underperform.”

Many funds hoped forex markets would offer better returns this year as the global crisis eased. But after a brisk start, with Japan’s “Abenomics” policy of monetary loosening fuelling heavy trading in the yen, others have also suffered as big trends failed to materialise.

“This was going to be the year of the dollar . . . Emerging markets were going to be very strong and everyone hated the euro, because they thought the only way the eurozone could grow was with a weaker currency . . . The exact opposite has happened,” says the head of trading at one investment bank.

Data from Hedge Fund Research show macro funds’ performance worsened in September, with its macro index down 0.2 per cent on the month and 2.1 per cent so far this year, against a rise this year of 5.6 per cent in its composite index.

“It’s been very disruptive, very painful,” Mr Jen says. “The last month, September, was bad for the dollar and that hurt a lot of people. Now there are two and-a-half months left of the year: those who are up want to preserve their profit and loss and those who are not want more clarity before they leverage up again.”

They will have to wait for clarity on the outlook for the dollar – even with a deal on the debt ceiling, it will now take time to assess the damage done to growth by the government shutdown.

In the meantime, strategists are devising new frameworks to interpret forex markets. HSBC suggests grouping currencies into three buckets: carry candidates, whose fortunes will be determined by their relative economic outlook; “diminished safe havens”, and a “balance of payments club”, chiefly of emerging markets, to be driven by the outlook for capital account financing.

Morgan Stanley advises grouping currencies into those that would be hardest hit by slower US growth; those that would benefit more from a delay to tapering; and those that would be least or most exposed to a big burst of risk aversion.

But, whatever the outcome in Washington, JPMorgan sees few immediate opportunities. “G10 carry offers almost the least value in history, and emerging markets carry generally requires buying currencies with low growth momentum. Prospects for other types of positions remain dim until central banks are back in play next year. For the next few months, almost all central banks are huddling on the sidelines.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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