Currency investing is making a comeback
These days, when investors talk about investing in currencies, they often think of crypto. But the hype around digital assets has drawn attention away from trading opportunities in traditional currencies, including the euro, pound, and Australian, Canadian and US dollars.
In the 1990s, George Soros made billions trading currencies. First, he shorted the pound, betting that the Bank of England was not going to keep its overvalued, high-interest currency in line with the precursor to the euro as the UK fell into a tailspin. recession. He later shorted Southeast Asian currencies, anticipating that they would no longer be able to maintain their peg to the dollar and the huge foreign debt that link had attracted.
While they don’t portend returns like anything Soros has achieved, currencies present attractive investment opportunities. Alpha trading in one of the biggest markets – partly due to geopolitical turmoil, soaring commodity prices and rising interest rates – is back in vogue, traders say for a long time.
The size of fiat currency markets dwarfs crypto, with daily trading exceeding $7 trillion, according to estimates derived from data from the Bank for International Settlements. Fiat currency trading is also not as dynamic as it once was. The consolidation of Western European currencies into the euro eliminated a host of transactions once triggered by the actions of independent central banks. Expansive liquidity, trading efficiency and market transparency have also helped to reduce currency volatility.
Moreover, 90% of currency investments are not designed to move currencies like Soros and others have done. Multinationals, central banks, investment managers and tourism-related businesses are simply looking to hedge against future currency risk.
Yet, significant macroeconomic events can trigger currency movements. According to many industry observers, including longtime currency investor Jeremy O’Friel who runs Belmont Investments, “we are apparently at a major inflection point in exchange rate movements.”
O’Friel sees three factors collectively leading to volatility. First, central banks have started raising interest rates, which will single out yields where they were non-existent across the board. Second, rising commodity prices favor countries that export energy, metals and food. And third, the war in Ukraine and all the uncertainty it brings is fueling volatility.
Early March, The Economist reported that “Russia’s invasion of Ukraine triggers the biggest commodity shock since 1973. The turmoil unfolding in the energy, metals and food markets is wide and wild. .. with commodity prices up 26% from the start of 2022.”
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A recent poll conducted by Reuters found that 90% of currency analysts polled expect many currencies “to be in a bumpy ride with already heightened volatility expected to pick up” at least through the spring.
The collapse of the Russian ruble has also refocused attention on exchange rates. Following a remarkably unified and aggressive response from the developed world against Russia, the ruble lost 40% of its value against the US dollar in just two weeks. This decline is accompanied by the closure of a wide range of foreign business activities in Russia and Russian business activities abroad. This turned Russian bonds – sovereign and corporate – into very distressed debt, which attracted a number of institutional investors to buy such heavily discounted papers. (Today the Russian government made an interest payment to foreign bondholders to avoid its first default in over a century.)
NBC News reported that Goldman Sachs “acts as a broker between Moscow’s creditors and U.S. investors, offering clients the opportunity to take advantage of Russia’s war-crippled economy by buying its debt securities at low prices.” price now and reselling them at a premium later, according to four financiers from global sources familiar with the strategy… On March 4, as Russia attacked Ukraine, the investment bank’s research team (JP Morgan) released a report recommending clients buy Russian corporate bonds.
This is an example of high-risk and morally dubious currency investing, as it is based on Russia’s re-integration into the global economy in the not-too-distant future. But there are a growing number of more conscientiously acceptable transactions that investors can easily access and potentially profit from. The appeal of these investments: they are pure alpha and uncorrelated to major equity markets. And the use of leverage can significantly increase small nominal returns (as well as risk).
In the weeks following Russia’s invasion of Ukraine, the dollar has appreciated more than 5% as investors turn to safe-haven currencies away from war. With most observers believing that the conflict will become more violent, the dollar should continue to recover.
American investors, whose portfolios are overweight in national securities, do not benefit from this decision. A stronger dollar will hurt overseas sales of US-made goods and services. Gaining long dollar exposure through various currency pair trades involves making a separate investment in the greenback.
There has also been a strong rotation from euros to Swiss francs due to Switzerland’s historic status as a safe haven – despite the country’s unusual participation in sanctions against Russia. The switch from the euro to the Australian dollar has been even more pronounced given Australia’s wartime distance, its limited exposure to Russia and the support the Aussie is receiving from soaring commodity prices. raw. Spreads between Australian 10-year sovereign yields and US 10-year Treasuries have now shifted in favor of Down-Under debt.
Belmont’s O’Friel thinks one of the most compelling exchanges driven by expanding interest rate differentials will be the US dollar and the yen. “That cross rate was $1 = 103Y in December 2020 when markets started to think the Fed should start raising overnight rates,” O’Friel says. He notes that the exchange recently hit 118Y and within a year he thinks the dollar could hit 130Y.
Investors should note that daily movements in exchange rates are driven by headlines. Craig Erlam, senior foreign exchange analyst at Oanda, a global currency specialist, notes that a recent break in trend “is driven by premature optimism that ceasefire talks between Russia and Ukraine could carry their fruit”. But barring a demonstrative Russian military withdrawal from Ukraine, most observers believe the current move toward safe-haven currencies, commodities and higher interest rates will continue.
Get currency exposure
Institutional investors can gain pure exposure to many cross rates by purchasing currency futures, forward contracts, and currency swaps. These are sophisticated leveraged trades that are marked-to-market daily.
Retail investors can gain substantial currency exposure in several different ways. But they require thorough research before investing.
Whenever someone buys foreign US certificates of deposit, for companies such as British drinks maker Diageo or Australian mining giant BHP, they are directly exposing themselves to the local currency. Buying common stock in a stock’s home market is a purer game, devoid of any US market variation. Buying foreign corporate and sovereign debt is also an effective way to gain exposure.
But foreign stocks and bonds come with various fees and exposure to underlying issuers and related markets, which could increase or decrease currency performance.
Then there are many mutual funds and ETFs that track stocks from specific foreign countries whose underlying prices are based on specific currencies.
For more targeted currency exposure, Invesco, PIMCO, iPath, WisdomTree and ProShares offer currency funds that are long or short in a particular currency and if desired, some funds offer leverage in both directions. Currency funds provide such exposure by establishing cross rates which, in any case, are long (or short) on the desired currency.
Finally, any investor can buy major foreign currencies and store them in a domestic brokerage account. He will pay no interest. To achieve this, investors would need to open a foreign savings account in a specific country, which might not be easy to do. This may involve being in the country to settle and there is a lot of paperwork involved. But if you happen to go to such a place for work or vacation, you can still use these accounts to pay for your trip – hopefully at a better exchange rate than the one at which you bought the currency.
Eric Uhlfelder is an award-winning journalist who has covered capital markets for three decades. He is also the author of the annual Global Hedge Fund Survey, which includes statistical information on each of the top 50 funds, as well as manager profiles and interviews. Contact Eric at [email protected]