A pick up in currency market volatility over the last few days after years of suppression by central banks’ easy-money policies has prompted some investors to look again at protecting against, or profiting from, sharp moves.
To hedge or not is a question that divides asset managers, with some actively buying and selling currency exposure through derivatives to boost or protect returns, and others refusing to spend the money, viewing the long-term impact as neutral.
Even when they do hedge to protect earnings from overseas, many focus on bonds rather than equities, given currencies often move inversely to the more volatile stock market and the impact of adverse currency swings is bigger on fixed-income assets.
But as global central banks look to tighten policy, lowering expected market returns, the perceived risk from a currency move rises – a leading index of implied currency volatility is up by half over the past five weeks.
It can be justified: the dollar fell 10 percent in 2017 against the currencies of its main trading partners while sterling rose steadily.
These moves were relatively gradual, lacking the spikes of volatility that marked previous shifts thanks to the numbing effect of the trillions that central banks poured into financial markets after the 2008 global crisis. But the anaesthetic is being slowly withdrawn, led by the U.S. Federal Reserve which has already raised interest rates five times this cycle.
The $4 trillion wiped off global stocks from record highs only eight days ago is a timely reminder that, as Rabobank analysts noted, “one-way bets don’t exist”.
On top of this, major currency swings can make a big difference to the end-of-year returns for active fund managers invested in foreign markets as they fight to prove their skill to clients who have one eye on cheaper, index-fund alternatives.
Sterling’s 20 percent rise to a post-Brexit referendum high of $1.43 in late January, coupled with uncertainty over future moves as Britain negotiates to leave the European Union, has prompted others to act.