Currencies are emerging as the new playing field for investors looking to profit from sharp price swings, after the aggressive central bank response to Covid-19 deprived them of opportunities in the bond markets.
Government bond yields have fallen to record levels this year – reflecting rising prices – after central bankers moved quickly in March to cut interest rates and launch bond buying programs for counter the economic effects of the coronavirus. Investors now face not only the prospect of near zero or negative returns on the safest debt, but also a collapse in volatility that has frustrated short-term betting.
But while bond markets move sideways, currency markets remain volatile. Even after the most intense phase of the Covid-19 crisis, volatility is well above levels seen 12 months ago, based on broad measures of price movements such as the JPMorgan Global FX Volatility Index.
The British pound was a prime example, losing 4% of its value last week after Brexit fears returned. The yields of British vests, meanwhile, were largely stable.
“In this low-yielding world, the exchange rate will become more important and bond managers will have to look more to currencies to generate returns,” said Jack McIntyre, portfolio manager at Brandywine’s Global Fixed Income Fund. Global, an asset based in Philadelphia. director.
Bond markets collapsed amid the height of pandemic fears in March, as even the safest government debt succumbed to liquidation. Drastic central bank actions restored order, but also led investors to bet that policymakers would seek to control bond prices for years to come.
The ICE BofA Move Index, which tracks expected volatility in the US Treasury market, has come close to record lows since May, after hitting its highest level for more than a decade in March.
Since then, currencies have become the pressure valve for macroeconomic adjustments, investors say, as well as the primary market for political events.
The dollar index has lost more than 6% since the start of April, declining steadily as confidence returned in the global financial system and investors digest the impact of lower interest rates in states -United as well as the hard blow to the economy of Covid-19. During this period, the yield on the 10-year US Treasury did not deviate from its current level of just under 0.7%.
As a result, the so-called bond vigilantes – investors who would punish spending governments by betting on their debt – instead turned their firepower on the forex markets.
Dickie Hodges, bond fund manager at Nomura Asset Management, bet earlier this summer that huge US government bond issues, along with the Fed’s growing tolerance for inflation, would lead to higher yields on US Treasuries.
But as it became clear that the Fed’s big bond purchases would limit returns, he changed his strategy, instead using currency options to position himself in a weaker dollar.
“The rate markets can’t really go anywhere right now because then governments couldn’t fund themselves, and the Fed and other central banks won’t let that happen,” Hodges said. “It pushes people into other avenues, including FX.”
Some investors are also concerned that government debt will no longer serve its traditional purpose in a long-term investment portfolio as a counterweight to riskier assets, tending to rise when stocks fall and vice versa.
“Bonds are still safe havens, but the problem is, you can’t balance losses on stocks and gains on bonds anymore because of the very low yields,” said Kaspar Hense, a senior bond fund manager. at BlueBay Asset Management.
Russell Silberston, investment strategist at Ninety One, said the asset manager has increasingly used bets on a higher Japanese yen or Swiss franc – currencies that typically rise during times of market stress – such as alternative hedge for its equity exposure. “FX is much more volatile than bonds, so there are more opportunities,” he added.
As central bankers capped fixed income volatility, Paul Robson, currency strategist at NatWest Markets in London, said they would “find it difficult to do the same for currencies”, in part due to Political sensitivity: The United States maintains a watch list of countries it considers “currency manipulators.”
Traders are bracing for a stormy end to 2020. Options markets forecast strong exchange rate swings as the US presidential election comes in November and as the Brexit transition comes to an end.
Exposure to currency fluctuations will not always be welcome in portfolios designed to be low risk, said McIntyre of Brandywine.
“If a fixed income manager loses money on currencies, the dissatisfaction tends to be much greater than the reward for a profit,” he said. “No one likes volatility, but if you’re looking for currencies as a source of return, you’ll have to put up with it.”