Central bank clarity fades

The clear blue water of policy divergence that became apparent in the final quarter of 2015 now seems muddied.

The European Central Bank (ECB) suggested that the marginal efficacy of monetary policy is declining when ECB President Mario Draghi stated at the 10 March press conference that its scope to cut interest rates further is limited. Market reaction to comments from the Federal Reserve (Fed) has flip-flopped, with the central bank being viewed as decidedly dovish in April and subsequently hawkish in May.

While the Fed is currently expected to hike rates this summer in response to stronger data, any stumble will produce a strong counter trend and the narrative will change once again. Ultimately, central banks respond to economics. The potential schism in economic paths has created unusual currency reactions over the first half of 2016 and these could well continue.

We would note that the EUR/US$ is at the top of its recent trading range. In addition, investor positioning appears to have switched to short US$. In this environment, we believe a tactical opportunity to short EUR/US$ has been presented. There is also a case to be long the US$ given the more hawkish tone from the Fed.

Paul Lambert – Insight Investment, a BNY Mellon company

The clear blue water of policy divergence that became apparent in the final quarter of 2015 now seems muddied. The European Central Bank (ECB) suggested that the marginal efficacy of monetary policy is declining when ECB President Mario Draghi stated at the 10 March press conference that its scope to cut interest rates further is limited. Market reaction to comments … read more

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EM currency snapshot: The right time to buy?

Emerging market currencies are getting hit by three secular trends all at once: the drop in commodities prices (for commodity exporters), the drop in global growth expectations and negative capital flows away from emerging economies.

The early August devaluation of the Chinese renminbi (CNY) on its own appeared relatively benign. However the combination of the nearly 2% devaluation with the above forces, the added  political dimensions and the on-going uncertainty on Chinese GDP growth led to a spike in volatility across emerging market currencies.

In contrast to the fixed exchange rate band for the renminbi (CNY), the free-float South Korean won (KRW) provides a useful barometer of EM Asia currencies. We can see how the won (KRW) volatility term structure responded similarly to initial renminbi (CNY) devaluation. But contrary to the offshore renminbi (CNH), the expected volatility of the KRW has since risen further – signalling that market participants anticipate even more exchange rate volatility in the coming months.

Sam Valtenbergs – Mellon Capital, a BNY Mellon company

Emerging market currencies are getting hit by three secular trends all at once: the drop in commodities prices (for commodity exporters), the drop in global growth expectations and negative capital flows away from emerging economies. The early August devaluation of the Chinese renminbi (CNY) on its own appeared relatively benign. However the combination of the nearly 2% devaluation with the … read more

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Low volatility breeds currency contempt

Volatility levels in major asset classes

Low volatility in the foreign exchange market has created a very challenging environment for anyone trying to generate returns. Consensus trades have been shaken out and many managers are now reluctant to take aggressive positions. We remain convinced that diverging central bank policy will eventually be reflected in exchange rates so maintain our short euro, long US dollar (USD) and short Japanese yen (JPY) positions. USDJPY has been highly correlated with US Treasury yields and the rally in bond prices is beginning to unwind with more positive data. The one area of FX where there is some momentum is emerging markets and we have been selectively buying high carry currencies such as the Brazilian real, but balancing it with short positions in other beta currencies such as the South African rand.

Paul Lambert, Head of Currency, Fixed Income, Insight

Low volatility in the foreign exchange market has created a very challenging environment for anyone trying to generate returns. Consensus trades have been shaken out and many managers are now reluctant to take aggressive positions. We remain convinced that diverging central bank policy will eventually be reflected in exchange rates so maintain our short euro, long US dollar (USD) and … read more

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EM currencies: not all weakness is bad

Best and worst spot returns across emerging markets*

Emerging market currencies have been at the forefront of negative sentiment in recent times, yet to assume all currencies are highly volatile is inaccurate.  Over the last six months a currency adjustment has taken place, we believe, either due to market pressure, or due to deliberate policy shifts.  Not all weakness is bad, and not all currencies have weakened.

*Source: Bloomberg. Spot currency returns based on a 6 months period in USD to 18.02.2014

Colm McDonagh, Insight Investment

 

Emerging market currencies have been at the forefront of negative sentiment in recent times, yet to assume all currencies are highly volatile is inaccurate.  Over the last six months a currency adjustment has taken place, we believe, either due to market pressure, or due to deliberate policy shifts.  Not all weakness is bad, and not all currencies have weakened. *Source: … read more

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