April Proves Cruelest Month for Traders Facing Loss: Currencies

May 02, 2014 6:21 am ET

(For a Currencies column daily alert: SALT FXCOL.)

May 2 (Bloomberg) -- Investors in the $5.3-trillion-a-day foreign-exchange market heartened by a return to gains in March found themselves shocked back to reality in April.

Parker Global Strategies LLC’s Global Currency Managers Index, which tracks the performance of 14 funds it considers the best in class, slid 1.5 percent last month, the most since July and almost twice the 0.8 percent jump posted in March amid a recovery in emerging markets. Volatility, which investors and traders exploit for profit, has fallen to pre-financial crisis lows, tempered by unprecedented amounts of cheap central-bank cash and record-low interest rates around the world.

“Until we get away from this central-bank, zero interest- rate policy worldwide, we’re going to have what we have -- which is bizarre behavior in financial markets in terms of pricing, including in foreign exchange,” David Kotok, the chairman and chief investment officer of Cumberland Advisors Inc., which manages $2 billion, said in an April 30 phone interview from Sarasota, Florida. Traders “don’t have the trading ranges and the volatility to profit,” he said.

There are few signs that will change anytime soon. Fed Chair Janet Yellen this week disappointed those hoping she might accelerate cuts to the U.S.’s stimulus program or give a firm signal as to when rates will rise. At the same time, traders are betting that neither the European Central Bank nor the Bank of Japan are ready to shift monetary policy.

‘Bad News’

“These quiet times could last even longer than the market expects, which could mean more bad news,” Olivier Korber, a currency-derivatives strategist at Societe Generale SA in Paris, said in a phone interview on April 29. “It’s very difficult to make money in foreign-exchange markets without a trend and with such low volatility. With central banks very predictable, we don’t have the ingredients needed.”

The Fed maintained on April 30 the $10 billion-a-month reductions to its bond-purchase program and kept its guidance on the outlook for borrowing costs, reiterating that it will consider a “wide range of information” in deciding when to lift the benchmark federal funds rate from a record-low zero- to-0.25 percent range.

Only two of the 33 economists surveyed by Bloomberg expect the ECB to cut its main refinancing rate from an all-time low of 0.25 percent when it meets May 8, even as euro-area inflation remains at a quarter of the bank’s 2 percent target. The Bank of Japan this week expressed confidence it could boost inflation to meet its target, lowering the chances of additional monetary easing this year even as the economy weakens.

Volatility Plunges

Anticipated price swings on major currencies are approaching multi-decade lows as a result.

Implied three-month volatility on the euro-dollar exchange rate, the most commonly traded currency pair, fell to 5.56 percent yesterday, the least since July 2007 and about half a percentage point from the lowest level since the shared currency’s 1999 debut.

The same measure for the pound tumbled to 5.16 percent today, from 7.58 percent on Jan. 3 and approaching the 4.90 percent level in June 2007 that was the lowest since 1996. Yen implied volatility reached 6.97 percent, the least since October 2012 and compared with an all-time low of 6 percent in 2007.

Forecasts Upended

Frankfurt-based Deutsche Bank AG, the world’s biggest currency trader, blamed lower volatility when it reported April 29 that foreign-exchange revenue fell “significantly” in the first quarter.

At the end of 2013 currency strategists forecast the dollar would surge as the Fed reduced bond purchases. That was derailed by a sluggish economy. The 0.1 percent gain last quarter for the U.S. Dollar Index, which InterContinentalExchange Inc. uses to track the currency against six major trading partners, lagged behind the 2.6 percent advance predicted in a survey at the end of 2013. The gauge is down 0.6 percent in 2014.

“Currency trading in 2014 has been a case of consensus destruction,” Mike Moran, a senior foreign-exchange strategist in New York at Standard Chartered Plc, said in an April 29 phone interview. “Probably the biggest consensus trade gone wrong this year is that U.S. yields would be a lot higher than they are -- and that has a strong influence in currency markets.”

Parker Index

Yields on short-term U.S. Treasuries are little changed this year, while those on longer-term debt are down. Treasury two-year notes yield 27 basis points more than similar-maturity German bunds, compared with last year’s high of 29 basis points on July 9. A basis point is 0.01 percentage point.

April’s drop in the Parker Global returns index left the gauge 2.5 percent lower this year and brought its decline since the end of 2010 to more than 10 percent. The Stark Currency Managers’ Index, which tracks 70 mainly commodity linked funds with $3.7 billion in assets, has fallen 3.6 percent in 2014. Both measures are into their fourth year of losses.

One way that dealers are turning the decline in volatility to their advantage is with the carry trade, where investors buy high-yielding assets using money borrowed in currencies of nations with low borrowing costs. Smaller price swings lessen the chance that the return gets wiped out by currency moves.

Investors are rushing to put on these trades, benefiting mainly emerging-market currencies with relatively high rates. A UBS AG index that tracks returns from the trading strategy has jumped 3.8 percent this year, while a Bloomberg gauge of 20 developing-nation currencies rose for a third month in April, after the worst start to a year since 2009.

‘Best Scope’

“All is not lost,” Bilal Hafeez, the global head of currency strategy at Deutsche Bank, said in an April 30 note. “Opportunistic forays into emerging-market carry most likely provide the best scope” for making money in foreign exchange this year, he said.

The pain foreign-exchange traders are suffering is made all the more difficult by this year’s surge in equity markets.

The unprecedented flood of central-bank cash that has damped volatility and reduced currency traders’ returns is a boon for stock brokers, with the Standard & Poor’s 500 Index surpassing its pre-crisis peak of 1,576.09 in October 2007 to reach a record 1,897.28 on April 4. Global bonds are generating their best returns through the first four months of a year on record, Bank of America Merrill Lynch index data show.

Enduring Trend

“The one thing that could cause a pick-up in volatility would be if you saw some genuine signs of inflation emerging, but we’re far from that now,” Adam Cole, the head of Group of 10 currency strategy at Royal Bank of Canada in London, said April 30 by phone. Traders are struggling “because falling volatility has been preceded by a huge compression in interest- rate spreads. And there are better reasons to think the low- volatility trend will endure.”

The Fed repeated April 30 that its long-term inflation expectations remain stable. The central bank’s preferred gauge of consumer prices climbed 1.1 percent in the year through March and hasn’t reached its 2 percent goal since April 2012. A Commerce Department report the same day showed that growth slowed to a worse-than-expected 0.1 percent annual pace in the first quarter, down from 2.6 percent in the prior three months.

“Aggressive traders really live on volatility, and it just hasn’t been that much,” Robert Sinche, global strategist at Stamford, Connecticut-based brokerage Pierpont Securities LLC, said by phone on April 30. “This year has been extremely difficult.”

--With assistance from Kevin Buckland in Tokyo and Ash Kumar in London.