Fridays UK GDP figure capped another remarkable week in the currency markets; the precipitous weakening of Sterling returning it to levels not seen for 6 years against major trading partner the dollar, and to unchartered levels against the euro. This devaluation was not an isolated case as higher yielding currencies worldwide generally felt the heat. The trend towards the safety of the Dollar turned into a mad dash, and the unwinding of Yen carry trades left many currencies values hammered to the wall.

Since late last year, we have seen markets crumble one by one. The first market to fail was the US subprime housing market which triggered the financial crisis. As this market imploded, we have in turn observed credit markets dry up, commodity prices fall and equity markets crash. The most recent, but almost certainly not the last event in the crumbling house of cards occurred last week as the carry trade bubble burst, causing investors to flood into Dollar and Yen and out of higher yielding pairings.

The carry trade is simply borrowing at low yielding currencies (typically the Yen), and using the funds to buy higher yielding assets elsewhere. It has become an increasingly popular strategy among Hedge Funds, as well as private and institutional investors, and this cheap form of leverage was partly responsible for driving the financial markets higher during the most recent bull run. Last week, as markets faltered we have witnessed a massive unwinding of these positions and strengthening of the low yielding currencies. Conversely, the unwinding has seen the higher yielding currencies getting sold down dramatically. The Aussie dollar suffered its worst daily fall in 32 years on Friday; the unwinding was so severe against the Yen that the pairing had barely enough liquidity to make a market at times. The Turkish Lira, South African Rand and New Zealand Dollar were also strongly devalued amongst the turmoil.

The extent to which Emerging markets and their currencies are battling is illustrated by the MSCI Emerging markets equity index which tumbled 15% throughout the week. Investors are selling off these countries assets and therefore currencies as they see these countries risk situation as increasing. Emerging Market Debt spreads (which is the risk premium demanded by investors for holding the risky securities) widened to a 6 year high last week showing the extent of the distrust. The worry at home is that investors will continue to assess the pound and UK economy as a risky prospect, with soaring public debt and a large current account deficit. 

Until this fear subsides and the dust settles on financial markets worldwide, the carry trade will remain out of favour with investors. Then once again we can expect the carry trade to rise from the ashes of the crisis.

Central banks continued to flex their muscles via the monetary policy channel throughout the week. Hungary and Denmark hiked rates in an attempt to strengthen their currencies, while New Zealand, Sweden and India cut theirs. Equity markets are still at sickening levels after some big sell downs late in the week.

The US takes its turn at announcing GDP figures on Thursday, and the other big piece of data is the FOMC rate decision Wednesday. We also look for further action from commodity and equity markets to again provide direction for currencies this week.

Trade of the week

This week’s trade of the week was for a client selling Euros and buying Sterling. They were guaranteed a worst case rate (WCR) of 1.27 and can participate in 40% of the favourable movement downward from the WCR. The client hedged all of their exposure over a one year period, with no premium payable for this strategy. For full details of this structure please contact one of our options traders on 0207 801 9050.

Enjoy the week ahead.

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Please feel free to contact me (rick.roache@worldfirst.com) if you have any questions or thoughts regarding these updates or if you are interested in a particular event in the calendar. If you would like to discuss your foreign exchange requirements, please contact our:

Corporate Foreign Exchange Team on 020 7801 9050 or our Private Client Currency Exchange Team on 020 7801 9080.

To view any past or present currency blogs please click on the following link www.worldfirst.com/blog

Disclaimer: The above comments are only our views and should not be construed as advice. You should act using your own information and judgement. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgement as of the date of the briefing and are subject to change without notice.

Any rates given are “interbank” i.e. for amounts of £5million and thus are not indicative of rates offered by World First for smaller amounts. E&OE. Definitions of jargon/market terms can be found in our Glossary of Foreign Exchange Terms.

This financial promotion is issued in the United Kingdom by World First Markets Limited which is authorised and regulated by the Financial Services Authority (“FSA”) to provide advice on and execute trades in derivatives.  Please note that other activities that may be referred to in this material, such as the execution of spot foreign exchange trades, do not fall under the remit of the FSA.  World First Markets Limited’s FSA Firm Reference Number is 477561.

Investing in any of the hedging strategies contained in this material involves certain risks, for example that the exchange rate at expiry of the contract is less favourable than if you had entered into a forward contract.  Please ensure that you fully understand these risks before investing.  If you are in any doubt as to the nature of these risks, please speak with your financial adviser or an adviser at World First Markets Limited.

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