Fixed Income and Currency Strategist

Gautam Jain, PhD, CFA

FX & Rates

In this note, we evaluate whether hedging with the euro would have helped ameliorate losses from EM currencies over the past couple of months stemming from the spillover from rising US rates.The attached file is a snapshot of EM currency market, which we produce daily, and where we seek to identify the leaders and laggards among currencies by comparing the performance of each to its history as well as to other currencies based on their respective betas to the broad market.

In this note, we evaluate whether hedging with the euro would have helped ameliorate losses from EM currencies over the past couple of months stemming from the spillover from rising US rates.The attached file is a snapshot of EM currency market, which we produce daily, and where we seek to identify the leaders and laggards among currencies by comparing the performance of each to its history as well as to other currencies based on their respective betas to the broad market.

FX Dashboard: How Well Would a Euro Hedge Have Worked for EM?

In today's note, we look at the EM FX-EUR correlation and recommend funding positions in EM currencies in euro for the time being. The attached file is a snapshot of the EM currency market, which we produce daily, and where we seek to identify the leaders and laggards among currencies by comparing the performance of each to its history as well as to other currencies based on their respective betas to the broad market. The analysis, therefore, is not a forecasting tool but to be used for identifying dislocations, which we loosely define as price moves that cannot be justified by fundamentals.

In today's note, we look at the EM FX-EUR correlation and recommend funding positions in EM currencies in euro for the time being. The attached file is a snapshot of the EM currency market, which we produce daily, and where we seek to identify the leaders and laggards among currencies by comparing the performance of each to its history as well as to other currencies based on their respective betas to the broad market. The analysis, therefore, is not a forecasting tool but to be used for identifying dislocations, which we loosely define as price moves that cannot be justified by fundamentals.

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Olivier Desbarres

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4X Global Research

4X Global Research was founded in 2017 to provide institutional and corporate clients with the substantive research, high-quality analysis and thoughtful insight on Emerging and G20 economies and financial markets they need to make informed and timely decisions and gain an edge in their investments.

This report updates the monthly seasonal patterns of 31 major Nominal Effective Exchange Rates(NEERs) going back to January 2010, using over two million daily data points with trade-weights derived from the<a href="https://www.bis.org/statistics/eer.htm" target="_blank" rel="noopener">BIS</a> (April 2019) and national central banks (see <a href="https://gallery.mailchimp.com/948838a86ce72ab6d8019a39d/files/15f4d8a9-56a4-46fd-9d78-607e5fd523e6/4X_Global_Research_Nominal_Effective_Exchange_Rates_Monthly_seasonal_patterns.pdf" target="_blank" rel="noopener">Nominal Effective Exchange Rates: Monthly seasonal patterns</a>, 10th January 2019). A number of factors can drive currency seasonality, including underlying seasonal patterns in balance of payment flows, the timing of public holidays and market liquidity. Identifying monthly seasonal patterns and why they may break down (significant changes in central bank or government policy, market positioning, macro data surprises and unexpected domestic events) can thus potentially augment investment returns and generate alpha.Unsurprisingly the Covid-19 pandemic – a once-in-a-lifetime “black swan” event – and accompanying measures such as national lockdowns severely disrupted typical monthly seasonal currency patterns in 2020, particularly in March and June (the trough and peak in global risk appetite) but also in Q4, with a few exceptions (see <a href="https://www.smartkarma.com/insights/monthly-currency-seasonality-down-and-out" target="_blank" rel="noopener">Monthly currency seasonality: Down and out?</a>, 4th January 2021). A number of emerging and developed market currencies continued to deviate from their 2010-2019 historical patterns in January 2021. In particular the “normally” strong Brazilian Real and to a lesser extent Colombian Peso and Polish Zloty depreciated. The Swiss Franc, contrary to history and in line with our forecast, also weakened slightly. The South African Rand depreciated 2.1%, five times as much as its 11-year historical average.Conversely the “normally” weak Turkish Lira was the outperformer, with the NEER appreciating nearly 4%. Sterling, the Australian Dollar and Norwegian Krone also outperformed in January relative to their historical seasonal patterns. However, and while early days, about 17 currencies, including the Dollar, Euro, Kiwi Dollar, Mexican Peso and most Asian currencies performed in line with their historical seasonality.Based on 2010-19 data Thai Baht, Norwegian Krone, Hungarian Forint and Polish Zloty were strongest currencies in the month of February while Korean Won was the weakest.

This report updates the monthly seasonal patterns of 31 major Nominal Effective Exchange Rates(NEERs) going back to January 2010, using over two million daily data points with trade-weights derived from theBIS (April 2019) and national central banks (see Nominal Effective Exchange Rates: Monthly seasonal patterns, 10th January 2019). A number of factors can drive currency seasonality, including underlying seasonal patterns in balance of payment flows, the timing of public holidays and market liquidity. Identifying monthly seasonal patterns and why they may break down (significant changes in central bank or government policy, market positioning, macro data surprises and unexpected domestic events) can thus potentially augment investment returns and generate alpha.Unsurprisingly the Covid-19 pandemic – a once-in-a-lifetime “black swan” event – and accompanying measures such as national lockdowns severely disrupted typical monthly seasonal currency patterns in 2020, particularly in March and June (the trough and peak in global risk appetite) but also in Q4, with a few exceptions (see Monthly currency seasonality: Down and out?, 4th January 2021). A number of emerging and developed market currencies continued to deviate from their 2010-2019 historical patterns in January 2021. In particular the “normally” strong Brazilian Real and to a lesser extent Colombian Peso and Polish Zloty depreciated. The Swiss Franc, contrary to history and in line with our forecast, also weakened slightly. The South African Rand depreciated 2.1%, five times as much as its 11-year historical average.Conversely the “normally” weak Turkish Lira was the outperformer, with the NEER appreciating nearly 4%. Sterling, the Australian Dollar and Norwegian Krone also outperformed in January relative to their historical seasonal patterns. However, and while early days, about 17 currencies, including the Dollar, Euro, Kiwi Dollar, Mexican Peso and most Asian currencies performed in line with their historical seasonality.Based on 2010-19 data Thai Baht, Norwegian Krone, Hungarian Forint and Polish Zloty were strongest currencies in the month of February while Korean Won was the weakest.

Media and analyst reports focussing on the scope for further US Dollar weakness and Emerging Market currency outperformance have continued to proliferate in the past month. The consensus view is still seemingly that a Democratic administration will fuel large US twin deficits and expectations of higher domestics inflation while Fed will keep rates on hold, eroding the value of Dollar assets. At the same time a pick-up in global confidence, economic growth and risk appetite will benefit EM and commodity currencies.While the “safe-haven” Dollar weakened sharply and EM currencies outperformed in the wake of the US elections on 3rd November recent facts tell a different story. Since 10th December the Dollar Nominal Effective Exchange Rate (NEER) and GDP-weighted baskets of developed and EM currencies have been broadly flat according to our calculations. Central European and Latin American currencies, which outperformed in November, have underperformed in past five weeks. Emerging Asian currencies, including the Chinese Renminbi, have done little since 10th December pointing to still active central bank FX management. This price action has broadly tallied with our near-term view that EM currencies will be “prone to sharp sell-offs (even if short-lived)”.Our analysis suggests that the steepness of the US Treasury yield curve rather than inter-country yield spreads matters more for the Dollar.However, we think central banks and sovereign wealth funds’ diversification out of Dollars into other reserve currencies, including Euro, Sterling, and Canadian, Australian and Kiwi Dollars, between May and early December was the main driver of Dollar depreciation.Dollar NEER’s stability since 10th despite a further 2.7% gain in the S&amp;P 500 suggests this diversification process has stalled, which we think is partly due to stretched valuations. At the same time price action points to a rotation out of the Euro into Sterling.We stick with our view that Dollar depreciation may not resume for another couple of months and will in any case not be as broad based as in November/early-December with markets paying greater attention to domestic factors, including valuations.

Media and analyst reports focussing on the scope for further US Dollar weakness and Emerging Market currency outperformance have continued to proliferate in the past month. The consensus view is still seemingly that a Democratic administration will fuel large US twin deficits and expectations of higher domestics inflation while Fed will keep rates on hold, eroding the value of Dollar assets. At the same time a pick-up in global confidence, economic growth and risk appetite will benefit EM and commodity currencies.While the “safe-haven” Dollar weakened sharply and EM currencies outperformed in the wake of the US elections on 3rd November recent facts tell a different story. Since 10th December the Dollar Nominal Effective Exchange Rate (NEER) and GDP-weighted baskets of developed and EM currencies have been broadly flat according to our calculations. Central European and Latin American currencies, which outperformed in November, have underperformed in past five weeks. Emerging Asian currencies, including the Chinese Renminbi, have done little since 10th December pointing to still active central bank FX management. This price action has broadly tallied with our near-term view that EM currencies will be “prone to sharp sell-offs (even if short-lived)”.Our analysis suggests that the steepness of the US Treasury yield curve rather than inter-country yield spreads matters more for the Dollar.However, we think central banks and sovereign wealth funds’ diversification out of Dollars into other reserve currencies, including Euro, Sterling, and Canadian, Australian and Kiwi Dollars, between May and early December was the main driver of Dollar depreciation.Dollar NEER’s stability since 10th despite a further 2.7% gain in the S&amp;P 500 suggests this diversification process has stalled, which we think is partly due to stretched valuations. At the same time price action points to a rotation out of the Euro into Sterling.We stick with our view that Dollar depreciation may not resume for another couple of months and will in any case not be as broad based as in November/early-December with markets paying greater attention to domestic factors, including valuations.

Dollar – Diversification, Rotation and Valuations

Market volatility has been reasonably subdued in recent weeks, despite acute event (and macro data) risk in the next four weeks, including of course US presidential elections on 3rd November, and a number of significant macro, policy and geopolitical developments.In the past month volatility in major developed and emerging market currencies versus the US Dollar has only risen materially in the high-yielding Turkish Lira and Mexican Peso and the low-yielding Polish Zloty, Korean Won and more surprisingly the Taiwan Dollar.However, this is not a case of more confident financial market participants finding their feet, in our view, but rather a reflexion of financial markets unable to see through the smoke and reluctant to pit themselves against their peers going into year-end and/or test monetary authorities’ resolve at time of acute uncertainty. S&amp;P 500 (realized) volatility has edged lower since its early September spike, with markets seemingly undecided whether a Trump or Biden victory will be a net positive for equities.For similar reasons the Dollar, Euro, Sterling, Yen and Swiss Franc have shown little directionality since late-July. Headwinds and tailwinds for these reserve currencies have either tended to cancel each other or simply fade, leaving market participants in two-minds and opting for the path of least regret. Back in November 2019 we correctly predicted that “global FX volatility would rise in coming weeks, with the potential for a volatility spike in mid-December”. We once again think the risk is biased towards FX volatility rising in coming weeks, particularly given the still very uncertain outcome of US elections to be held in just 26 days.We think the risk of higher volatility is most acute if US President Trump once again defies opinion polls to win or if a prolonged period of uncertainty ensues in the event of either candidate contesting the result of a very close election.Moreover, the odds Sterling volatility spiking higher in the next fortnight are high, in our view, whatever the outcome of UK-EU negotiations over a new trade deal which will likely reach a crescendo ahead of the European Council meeting on 15-16 October.

Market volatility has been reasonably subdued in recent weeks, despite acute event (and macro data) risk in the next four weeks, including of course US presidential elections on 3rd November, and a number of significant macro, policy and geopolitical developments.In the past month volatility in major developed and emerging market currencies versus the US Dollar has only risen materially in the high-yielding Turkish Lira and Mexican Peso and the low-yielding Polish Zloty, Korean Won and more surprisingly the Taiwan Dollar.However, this is not a case of more confident financial market participants finding their feet, in our view, but rather a reflexion of financial markets unable to see through the smoke and reluctant to pit themselves against their peers going into year-end and/or test monetary authorities’ resolve at time of acute uncertainty. S&amp;P 500 (realized) volatility has edged lower since its early September spike, with markets seemingly undecided whether a Trump or Biden victory will be a net positive for equities.For similar reasons the Dollar, Euro, Sterling, Yen and Swiss Franc have shown little directionality since late-July. Headwinds and tailwinds for these reserve currencies have either tended to cancel each other or simply fade, leaving market participants in two-minds and opting for the path of least regret. Back in November 2019 we correctly predicted that “global FX volatility would rise in coming weeks, with the potential for a volatility spike in mid-December”. We once again think the risk is biased towards FX volatility rising in coming weeks, particularly given the still very uncertain outcome of US elections to be held in just 26 days.We think the risk of higher volatility is most acute if US President Trump once again defies opinion polls to win or if a prolonged period of uncertainty ensues in the event of either candidate contesting the result of a very close election.Moreover, the odds Sterling volatility spiking higher in the next fortnight are high, in our view, whatever the outcome of UK-EU negotiations over a new trade deal which will likely reach a crescendo ahead of the European Council meeting on 15-16 October.

Event Risk and Market Volatility: Partners in Crime

Germany

The euro is the official currency of the European Economic & Monetary Union. 

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Euro (USDEUR CURNCY)

FX Dashboard: How Well Would a Euro Hedge Have Worked for EM?

In this note, we evaluate whether hedging with the euro would have helped ameliorate losses from EM currencies over the past couple of months...

Gautam Jain, PhD, CFA

FX Dashboard: Fund EM FX in EUR

Attached is our daily FX Dashboard that highlights dislocations in EM currency markets. In today's note, we discuss EM FX-EUR correlation and...

Gautam Jain, PhD, CFA

Currency Seasonality’s Slow Comeback?

Identifying currencies' monthly seasonal patterns and why they may break down can potentially generate alpha. Seasonal patterns broke down in 2020...

Olivier Desbarres

Dollar – Diversification, Rotation and Valuations

Consensus view remains that USD will depreciate and EM currencies outperform. But that's not been the case in past 5 weeks as reserve...

Olivier Desbarres

Event Risk and Market Volatility: Partners in Crime

Market volatility has been reasonably subdued in recent weeks, despite acute event (and macro data) risk in the next four weeks, including of...

Olivier Desbarres

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