Analysis: Move over bonds, FX taking over as investors’ new favourite playbook


In this news, we discuss the Analysis: Move over bonds, FX taking over as investors’ new favourite playbook.

LONDON (Reuters) – Lack of action in bond markets is prompting bond investors to focus more on currencies to spot market trends, marking a turning point for gigantic but generally murky currency markets.

By buying bonds at the rate of about $ 2 billion (£ 1.5 billion) per hour in the wake of the COVID-19 pandemic, central banks have crushed volatility and reduced its effectiveness as an instrument of signage.

While the collapse of interest rate spreads is expected to lead to lower currency price movements, with rate changes and their relative levels being the main drivers of exchange rate movements, investors say the absence of these two factors makes currency markets more volatile.

This has major implications for investors to central banks as the former express their views on the economic outlook or major events through the bond markets, which the latter use as a key tool for transmitting their monetary policy. .

If bond markets are broken, currencies provide a alternative, say investors.

“It’s still early days, but anecdotal evidence from some conversations with clients suggests that they view currencies as an asset class for predicting market trends relative to earlier, when discussions would be about what the markets bondholders are predicting, ”said Robert Mcadie, head of interconnection. asset strategist at BNP Paribas.

A State Street index of the prices of various goods in different currencies shows that volatility is increasing for a range of currencies, including the US dollar, Chinese yuan, euro and British pound.

More generally, currency market volatility has fallen from a 1-1 / 2 year low reached at the end of July, while overall bond market volatility remains close to 2020 lows.

The rise in currency market volatility comes after at least five years of calm when major currencies are holding tight ranges.



With numb interest rate markets and an environment where central bank inflation targets are loosening, larger currency movements will be more common, as forex markets will increasingly bear the primary burden of reflecting major macroeconomic transactions or the risks of major events such as the US elections.

For example, the volatility of the closely watched bond volatility index is a third of what it was around the 2016 U.S. election.

Owen Murfin, institutional fixed-income portfolio manager at MFS Investment Management, a $ 528 billion fund, said he was “much more flexible in expressing your point of view” on forex markets than on rates.

Murfin, who said he had been “quite active” in swapping the Norwegian krone for the US dollar, is optimistic about the economic recovery of the oil-exporting nation.

He said the Norwegian bond market may be too small and relatively illiquid to express such views and there is low volatility.

This view is shared by Oliver Boulind, a senior bond portfolio manager at HSBC Asset Management who allocated more risk to Latin American currencies, including Chilean, Mexican and Colombian currencies this summer, than their bond markets.

As bond investors turn to currencies, policymakers follow suit.

Take the euro for example. Since the announcement of the European Stimulus Fund on May 18, the euro has rebounded more than 10% against the greenback with relative bond yields barely altered as the news mainly concerned debt pooling.

This has prompted the European Central Bank to comment more on the strength of the currency in recent days.

This is also reflected in tightly controlled currency markets like China where the yuan climbed to 27 months this week as bond yields remain largely contained with investors betting on the outcome of the US election.

Sentifi, a alternative data provider, say the relative success of Chinese authorities in dealing with the pandemic is also fueling the yuan’s gains.


Of course, switching from bonds to currencies is not easy. They are much more volatile than interest rates, with daily fluctuations of 1% to 2%, a common occurrence – important by the standards of bond investors who are accustomed to relatively small returns movements.

But that doesn’t deter investors. Data from Bank of America Merrill Lynch shows that the correlation between FX trading flows on their trading platforms and fluctuations in the currency market is increasing, suggesting that low volatility in the bond market is pushing more bond investors into the currency markets.

The growing contrast between calm bond markets and nervousness in currencies is also changing the behavior of so-called “carry trade” strategies where foreign buyers of US debt would generally leave the currency risk inherent in these transactions unhedged due to the costs of trading. high coverage.

But with interest rates close to zero in developed countries and the absence of volatility, Japanese buyers of US and European debt are increasingly hedging currency risks, as returns after hedging the purchase of these bonds are now in positive territory.

For example, Japanese investors bought a net 1.946 billion yen of US bonds during the week of October 4-10, according to data from the Ministry of Finance, the second largest weekly purchase this year.

“Our clients’ interest in currencies has never been higher. But there is a wait and see approach on the part of some investors. Do you want to put new capital to work before November 3? Probably not, ”said Russell LaScala, co-director of the global currency division at Deutsche Bank, referring to the date of the US presidential election.


Reporting by Tommy Wilkes and Saikat Chatterjee; Additional reporting by Hideyuki Sano in TOKYO and Dhara Ranasinghe; Edited by Hugh Lawson

Original © Thomson Reuters

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