America’s next CEO?

Paint it grey
Start with the advantages. The most important fact about Mr Romney is that he is a non-ideological man who did something that America needs a lot more of. In 2002 he was elected to govern Massachusetts, normally a Democratic stronghold. He passed a version of health-care reform that is at once his proudest achievement and his biggest liability. Back then a system based on obliging everyone to buy private health insurance was a conservative idea, and Mr Romney did a good job of working with a hostile legislature to get it passed. (Today, his party viscerally opposes Mr Obama’s health reforms, which are closely modelled on Mr Romney’s; such are the twists of politics.) He also turned round Massachusetts’s finances, just as he had earlier righted the Salt Lake City Winter Olympics. Mr Romney needs to make these successes count for more than they have so far. Once the primaries are over, and America’s independents rather than the Republican Party faithful become the electorate to win over, he may be able to.
Second, Mr Romney has something that the president and his Republican rivals sorely lack: business experience. For 25 years he made himself and the management consultancies BCG and Bain a lot of money by making companies more efficient which, yes, sometimes means firing people, but also drives economic growth (see article). So far, Mr Romney has done a poor job of defending himself against attacks which are really aimed at the creative destruction which is the essence of capitalism itself. He says he created a net 100,000 jobs during his time at Bain. That figure is impossible to prove, but he could do more to argue that the benefits outweigh the costs. His task has not been helped by disgraceful attacks from fellow-Republicans on corporate restructuring.
Third, Mr Romney seems sure-footed. It is hard to think of a single misstep in this campaign. He may be wooden, but no scandal has ever attached to him. His family life is impeccably monogamous and progenitive. Those who have worked closely with him tend to admire him. On both the economic and the foreign-policy sides, he has already put together impressive and above all sensibly moderate teams.
The debit side of the ledger
A useful list, to be sure: but can it outweigh the negatives? Mr Romney’s pragmatism has an inconvenient flip side: no one is quite sure where he stands. The Republican base does not think he is reliable on such things as gay rights and abortion. That will not matter so much to independents (who will probably also accept that any Republican has to say a few mad things to win a nomination). But people have to trust a president on the main issues, and, despite publishing a long economic manifesto, Mr Romney remains vague over how a lot of it is to be accomplished.

Explore our interactive map and guide to the race for the Republican candidacy

It is not at all clear how he would reform America’s ruinously expensive health-care and pensions systems. His views on what he wants to do about America’s 12m illegal immigrants are also unsettlingly gnomic. And where he has been clear, he has sometimes been wrong: his insistence that, on day one of his presidency, he will brand China as a currency manipulator represents dangerous pandering to populists. His pledge to cut federal spending to no more than 20% of GDP, a sop to his party’s fiscal extremists, would also be dangerous if applied as quickly as he implies.
Mr Romney will have other problems in wooing the electorate. He would be the richest candidate ever to win a big-party nomination and he reeks of privilege. His father was a governor as well, and he himself studied law at Harvard. On the other hand, Mr Obama is a millionaire several times over, can give a fair impression of having come from the planet Vulcan, and also studied law at Harvard. Mr Romney’s lack of charisma is a problem; but perhaps America wants fewer soaring speeches and more pragmatic restructuring plans.
Mr Romney’s last difficulty is one that should not be a problem at all. He is a Mormon and, despite Mormons’ protestations to the contrary, a third of Americans do not consider them to be Christians. There is not much Mr Romney can do about this. He could explain the Mormons’ extraordinary missionary work, but he can hardly risk saying that it is not really any more incredible that God communicated His plans to man in upstate New York in 1820 than He did in Palestine in 0AD. We recall, however, that America was for decades “not ready” for a Catholic president, or for a black one. Eventually, Americans thought better of those attitudes. Prejudice would be a silly reason for the Republicans to reject a man who offers their best chance of beating Mr Obama.

Behind every cloud, another cloud

A decade ago, Britain came through the dotcom bust with barely a scratch, thanks to a consumer-credit boom and deficit-financed public spending. Those days of easy credit are long gone: consumers are paying down their debts and government finances are deep in the red. The economy’s best hope lies with export demand, but this is growing scarce. The economic outlook for America, Britain’s biggest single-country export market, looks dark. The euro zone, where half of Britain’s exports go, is at risk of imploding.

In September the IMF cut its forecast for Britain’s GDP growth in 2012 to a sluggish 1.6%. Even that may soon look too optimistic; the Economist Intelligence Unit, a sister company of The Economist, expects 0.7% (see “The world in figures”). It seems far likelier that the economy will disappoint than offer a pleasant surprise. The British policy brass feels vindicated for its wariness about the single European currency but scepticism will be no protection against the fallout from the euro’s troubles. Britain is the one big country outside the currency zone that is heavily exposed to euro trouble through its trade and financial links.

Related topi

The continuing crisis in Europe will have implications for Britain’s deficit-cutting plans. The logic behind the government’s fiscal austerity is that the bond market’s ire can turn quickly from errant euro-zone countries to others (such as Britain) that have large budget deficits. But as Europe’s woes deepen, the harm done by sticking rigidly to the fiscal plan is likely to prove greater than any damage done by deviating from it.
That is in part because money pulled from the euro zone’s trouble-spots has to go somewhere. Some of it will end up in British government bonds, which will look among the soundest of the rich-country credits (admittedly not a healthy peer group). Meanwhile, a dearth of export orders for British companies will push the government to adopt measures in support of the economy. Deep cuts in the state’s day-to-day running costs, including reductions in welfare benefits, will go ahead as planned. But the Treasury will find itself having to finance new capital projects to make up for a shortfall in aggregate demand.
The economy will be lucky to avoid at least one quarter of contraction during 2012. The unemployment rate will be stuck above 8%, the highest rate since the mid-1990s. But two factors militate against a deep downturn.
First, businesses anxious about the economic outlook and fearful of a renewed tightening of credit conditions tend to trim their stocks, postpone planned investment and stop hiring new employees. But this tendency to conserve cash will be limited in the coming months because many British companies have already been piling up rainy-day money. The excess of corporate income over spending has risen above 4% of GDP. That offers a degree of protection against savage cuts in stocks, investment and jobs.
Easy does it
A second helpful factor is the prospect of lower inflation. It is set to fall steadily from a peak of 5% to around 2% by the end of 2012, as vat and energy-price increases drop out of the annual rate (see chart). That will bring some relief to hard-pressed consumers, who suffered a large fall in real income during 2011. Lower inflation will also make it easier for the Bank of England to justify a more aggressive dose of “quantitative easing” (QE)—boosting the money supply by buying government bonds. Because investors will be increasingly reluctant to finance commercial banks, amid worries about their exposure to the euro zone’s sovereign-debt problems, the Bank of England will find itself compelled (with Treasury backing) to buy long-term bonds issued by banks as part of its QE programme.

The pound is set to fall further against the dollar

London will look a cheap holiday destination for Americans next summer but a lot of Europeans are likely to stay at home. The pound is set to fall further against the dollar in the early months of 2012, in part because of Britain’s exposure to the euro zone but also because the dollar rises against other currencies when the world is in trouble. At the low point for the global economy in March 2009, the pound fell to $1.38. It could easily fall as far again in 2012 given how fearful investors are likely to become.
Only the euro looks more vulnerable to a fall. But it will not be much comfort for Britons that some other European economies will be in even worse shape than their own.

How to run the euro?

How to run the euro?

• er during the euro crisis: the markets and the politicians. In 2012 the battle will become a lot more complicated, as the politicians splinter into factions. It sounds dangerous—and it is—but thrashing out political arguments is an essential part of bringing the crisis to an end.

Amid the banks’ plunging shares and the soaring yields of government bonds, it is easy to lose sight of the political questions being asked of Europe. Markets have forced Europe’s troubled economies to confront austerity and reform, but politics will determine how they do so. Markets have demanded that Germany and other creditor nations finance a rescue, but politics will decide what they demand in return. Markets want a revamp of the euro’s governance, but politics will ordain how energetically the European Union embraces federalism.

Austerity and a rescue are now under way, though a descent of Greece into anarchy could yet throw them off course. But the third element—renovating the governance of the euro—is still highly uncertain. In 2012 Germany’s Angela Merkel and her fellow euro-zone leaders will set out the sketches for that design.

Try this for a blueprint

If you were sitting down with a blank sheet of paper, you would advise the euro zone to complement its one-size-fits-all monetary policy by pooling sovereignty and creating new institutions. You would set up a European mini-IMF (call it an EMF) with enough funds to tide over troubled countries as they adjusted their economies. A pan-European banking regulator and a bail-out fund could ensure that large European banks were not at the mercy of their vulnerable sovereign borrowers. To stop the markets from picking off weaklings, you might organise centralised borrowing—in which all countries jointly stood behind the debt of each government. And, to stop spendthrift governments from exploiting these mechanisms, euro-zone countries would agree to submit their fiscal policies to the say-so of everyone else.

It amounts to a blueprint for the United States of Europe. And it is utterly beyond reach.

For starters nobody can agree on which central authority should hold all these new powers. France and Germany would refuse to boost the European Commission, which they mistrust. Smaller countries and Germany’s constitutional court would refuse to endow an ad hoc intergovernmental council. Many national leaders heartily detest the European Parliament.

Moreover, many governments are nervous about other euro-zone countries having a say about their own public spending. And the entire EU was scarred by the eight-year-long attempt to restructure the union, first by writing a new constitution—rejected and abandoned—and later by repackaging the constitution into the Lisbon treaty, which limped into force in 2009. You do not find much appetite in Brussels for a repeat performance.

Shape up, for the euro’s sake

Where does that leave the redesign of the euro? Euro-zone governments have agreed that leaders will meet at twice-yearly summits. They have set up a proto-EMF and a European Banking Authority. And they have agreed to monitor the economies of euro-zone members in a souped-up Stability and Growth Pact.

New sanctions might require a new treaty

But more is needed, especially with sanctions. Some could be enforced at the level of the nation. Euro-zone members might have to write caps on deficits and debt into their constitutions, or create independent offices of statistics and budget sustainability, rather as they must have an independent central bank today.

Ultimately, though, new sanctions might require a new treaty. But new treaties take a long time. Countries can weigh them down with their own agendas (Britain, for instance, wants to repatriate powers even though it is not a member of the euro zone). And referendums can reject treaties (just ask the Irish).

These difficulties have answers and the EU has had more than enough practice in fashioning compromises out of unpromising ingredients. But if the euro zone gets it wrong in 2012, it will be laying the foundations of the next currency crisis. 

LBMA Forecasters See Gold Reaching $2,055 This Year

The London Bullion Market Association published the results of its Forecast on Monday, the firm’s annual survey on the direction of precious metals prices for the coming year.  The large majority of respondents – comprised of analysts and strategists from investment banks and other financial firms across the globe – predicted that gold will rise for a 12th consecutive year on its way to further new all-time highs.

The average maximum gold price estimate among the 26 respondents came in at $2,055 per ounce, a 6.9% increase over the yellow metal’s $1,923 record high in 2011.  In addition, the highest individual estimate came from UBS’s Edel Tully – last year’s most accurate gold price forecaster – who predicted that gold will reach a high of $2,500 per ounce in 2012.

The average of the mean gold estimates was $1,766 per ounce, 12.3% above the $1,572 average price in 2011.

While the analysts were quite bullish on gold in the year ahead, they were considerably less constructive on other precious metals.  The average estimate for silver in 2012 came in at $33.98 per ounce, 3.2% below 2011′s average of $35.11 per ounce.  Platinum’s 2012 average estimate was $1,624, 5.6% below 2011′s average of $1,720 per ounce. Lastly, palladium’s 2012 average estimate of $735.52 per ounce was just 0.3% above 2011′s average of $733.63 per ounce.

The numerical results of the LBMA Forecast are available at the web address below:

http://www.lbma.org.uk/assets/LBMA%20Press%20Release%202012%20Forecast%2020120106.pdf

The LBMA also noted that “The full survey, including specially written commentaries together with analysis of the historical performance of the Forecast, will be published later this month and posted on the LBMA website in mid-January.”

The Fukushima black box

The government was almost as clueless. Naoto Kan, then prime minister, had a crisis headquarters on the fifth floor of the Kantei, his office building. But emergency staff from various ministries were relegated to the basement, and there was often miscommunication, not least because mobile phones did not work underground. Crucial data estimating the dispersion of radioactive matter were not given to the prime minister’s office, so that evacuees like those from Namie were not given any advice on where to go. That is why they drove straight into the radioactive cloud. The report faults the government for providing information that was often bogus, ambiguous or slow. Perhaps the biggest failure was that nobody in a position of responsibility—neither TEPCO nor its regulators—had sought to look beyond the end of their noses in disaster planning. No one seems ever to have tried to “think the unthinkable”.
In America official reports such as those on the September 11th attacks or the Deepwater Horizon oil spill have become acclaimed books. This one is hardly a page-turner. A privately funded foundation, headed by Yoichi Funabashi, a former editor of the Asahi Shimbun newspaper, is doing a separate investigation, based partly on the testimony of TEPCO whistle-blowers. (One, according to Mr Funabashi, says the earthquake damaged the reactors before the tsunami, a claim that officials have always rejected.) It at least promises to have literary merit. Mr Funabashi, a prominent author, draws parallels between the roots of the disaster and Japan’s failures in the second world war. They include the use of heroic front-line troops with out-of-touch superiors; rotating decision-makers too often; narrow “stovepipe” thinking; and the failure to imagine that everything could go wrong at once.
Complex systems, jerry-rigged
For now, the risk is that the interim report does not get the attention it deserves. So far it seems to have aroused more interest on a techie website called Physics Forums, beloved of nuclear engineers, than in the Japanese press. The government, led by Yoshihiko Noda, has not yet used it as a rallying call for reform. One of its recommendations, an independent new regulatory body, will soon be set up. Others, such as new safety standards and broader evacuation plans, would take months to implement.
Such reports are, after all, confidence-building exercises. They are meant to reassure the public that, by exposing failures, they will help to prevent them from being repeated. In the case of Fukushima Dai-ichi there is still plenty to be nervous about. Although the government declared on December 16th that the plant had reached a state of “cold shutdown”, much of the cooling system is jerry-rigged and probably still not earthquake-proof. On January 1st a quake temporarily caused water levels to plunge in a pool containing highly radioactive spent-fuel rods.
Meanwhile, across Japan, 48 out of 54 nuclear reactors remain out of service, almost all because of safety fears. Until somebody in power seizes on the report as a call to action, its findings, especially those that reveal sheer ineptitude, suggest that the public has every reason to remain as scared as hell.

Banks Retrench in Europe While Keeping Up Appearances

LONDON — Stung by souring loans and troubled government bond portfolios, many European banks are being forced by regulators to raise money to build up their cash cushions against future losses.

That includes Santander, the Spanish banking giant that European regulators say has the biggest capital hole to fill: at least 15 billion euros.

So why, then, is Santander still planning to pay its shareholders 2011 dividends worth at least 2 billion euros in cash and even more in stock? That question goes to the heart of the economic challenge that Europe faces in the year ahead. A combination of government austerity, and the imposition of bigger capital safety cushions that are leading banks to retrench, seem all but certain to plunge the Continent back into recessionless than three years after emerging from the last one.
 But many banks are taking actions that will only intensify the blow. To preserve their allure as global brands, while trying to compensate for their battered share prices, big European banks like Santander remain intent on maintaining rich dividend payouts to shareholders. At the same time, they are selling assets, curbing lending and taking other belt-tightening measures to satisfy regulators’ demands for more capital.
“Our dividend is a sign of our expected future profits,” said José Antonio Alvarez, the chief financial officer of Santander. “Unless our expectations change we try not to cut the dividend.”
Santander, though by many measures the most generous, is not the only bank paying dividends as it scrambles to raise capital.
Its rival, the Spanish lender BBVA, plans to pay out nearly half its profits to shareholders, despite being under regulators’ orders to raise 6.3 billion euros in capital. To a lesser but still significant extent, Deutsche Bank and BNP Paribas will also be paying out dividends as they try to take in money to build their capital cushions.
All this is a sharp contrast to the way capital-short banks in the United States slashed dividends to conserve cash during the depths of the financial crisis that followed the Lehman Brothers collapse in 2008. The American government also injected cash into the banks, as Britain did with its weaker institutions.

So far, European governments have shown no inclination to do likewise for their banks. And critics say the contrast with the American experience shows how much European regulators are out of step, or even out of touch, with the banks they supervise — with potentially disturbing ramifications for the European economy.

“I do not think Europeans understand the implications of a systemic banking crisis,” said Richard Koo, the chief economist at the Nomura Research Institute in Tokyo and an expert on the financial stagnation in Japan in the 1990s. “When all banks are forced to raise capital at the same time, the result is going to be even weaker banks and an even longer recession — if not depression.”
A paper Mr. Koo wrote on the subject has gone viral on the Web, with many picking up on his recommendation that the banking crisis will not be solved until European governments inject large amounts of money into their banks.
“Government intervention should be the first resort, not the last resort,” Mr. Koo said in an interview.
There is little doubt that European banks need shoring up right now. That fact was made clear Wednesday, when 523 banks tapped the European Central Bank for a record 489 billion euros (nearly $640 billion) in loans. Compared with their American peers, they have been much more dependent on borrowing in recent years to finance their lending binges.
On average, European banks’ loan books exceed their deposits by 1.2 times. In the United States the average loan-to-deposit ratio is 0.70. The upshot is that it will probably take much longer for Europe’s banks to unwind their bad loans and debt than it has for American banks.
The European Banking Authority, after a third round of stress tests in October, has ordered Europe’s fragile banks to raise more than 114 billion euros in fresh cash in the next six months. By June 2012, the region’s financial institutions will need to increase their so-called core Tier 1 capital ratio — the strictest measure of a bank’s ability to resist financial shocks — to 9 percent of assets.
That ratio, higher than the 5 percent preliminary target that the Federal Reserve set for American banks this week, reflects the acute capital strains that European banks are facing.

Regarding www.skoptionstrading.com.  Our portfolio has now generated a profit of 374.43% since inception and we hope to keep it going that way next year.

 

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World GDP: The recovery fades

20-Dec (The Economist) — THE world’s recovery from recession is slowing, according to The Economist’s measure of global GDP, based on 52 countries. Third-quarter growth expanded by 3.6% across the world, down by 1.5% from the same period in 2010.

[source]

The Daily Market Report

Despite Correction, Gold Poised to Register Another Solid Performance in 2011
Bar1
23-Dec (USAGOLD) — Gold is consolidating just above the $1600 level going into the Christmas holiday. The last London gold fix of 2010 was $1405, so barring any dramatic price changes in the last week of the year, the yellow metal is on-track for yet another double-digit gain of about 14%.
That’s pretty impressive given the dramatic delveraging sell-off from the 1920.50 record high we saw in September, which prompted all manner of commentary proclaiming the end of gold’s decade-long rally. More recently — amid another bout of deleveraging associated with rising uncertainty about the fate of European Union — the yellow metal retested the September low at 1534.06 along with important channel support. While much was made of the technical damage done by the recent move below the 200-day moving average, gold continues to display good resilience, underpinned by solid fundamentals.

Monthly Gold Chart

Daily Gold Chart

Those supporting fundamentals are unlikely to change anytime soon as the world continues to seek solutions for an overwhelming level of debt and anemic growth prospects. Thus far, the focus remains on creating more of what is arguably to primary source of the problem. Debt.
Of course someone needs to buy that debt, so we have also witnessed unprecedented — and in some instances “unlimited” — liquidity pumps to perpetuate the now institutionalized game of “hide the debt.” I don’t think that anyone really believes that more debt is really the answer to our global debt crisis, but in staving off a complete economic catastrophe several years ago with massive deficit spending and liquidity schemes, the United States effectively set the tone. Actually, the US was simply following the example set by Japan more than 20-years ago; drive interest rates to zero and hold them there by printing currency and buying bonds with it.
In fact, Japanese debt is fast approaching ¥1 quadrillion! That rather ominous benchmark is expected to be surpassed by the end of Japan’s fiscal year in March. The BoJ’s balance sheet is a startling ¥138 trillion. Meanwhile the Fed’s balance sheet has contracted in recent months, but is still in excess of $2.7 trillion. But perhaps most troubling is the expansion of the ECB’s balance sheet. Despite their persistent assurances that quantitative measures simply aren’t an option, the ECB’s balance sheet has grown by nearly a third, approaching €2.5 trillion. Hey Mr. Draghi, if you’re not engaged in QE, explain that exploding balance sheet.
There are policymakers in Europe, including ECB board member Lorenzo Bini Smaghi, that favor true — or at least un-obscured — quantitative easing by the ECB to prevent another recession in Europe. Imagine the implications for the central bank’s balance sheet if the objections are ultimately circumvented.
Late in December, the ECB unleashed a wall of money, €489 bln ($638 bln) in 3-year LTROs to 523 eurozone banks. The positive reaction to all this new liquidity was very short-lived. The euro remains under pressure and eurozone spreads have widened back out.
As the FT’s Gillian Tett pointed out in a recent column, the hope was that the banks would use this abundance of cheap ECB money to buy European sovereign debt, much in the same way that US banks plowed the proceeds from mortgage backed securities sales to the Fed into US Treasuries. Basically, the private sector ends up financing the government with funds provided by the government. Being in the middle of this financing cycle results in a potential profit bonanza for the banks.
ZIRP and liquidity. Liquidity and ZIRP. From here to eternity…
There are growing rumblings that the Fed is about to extend their ZIRP guidance from mid-2013 out to 2014 and potentially beyond. I’m sure when the BoJ launched their quantitative measures they were expected to last maybe a couple of years. Here it is 20 some years later and Japan still has 0% interest rates. Do you suppose this is our fate as well?
Some of the major financial firms are predicting lofty average gold prices for the coming year: Goldman Sachs $1810, Barclays $2000 and UBS $2050 to name just a few. We maintain that the long-term uptrend in gold is protected as long as we remain in a negative real interest rate environment. This in fact seems all-but assured for quite some time. On top of that, the ongoing expansions of debt, monetary bases and central bank balance sheets, along with broadly positive supply/demand dynamics — highlighted by robust investment and central bank demand — conspire to underpin gold as well in the new year.
On behalf of everyone here at USAGOLD – Centennial Precious Metals, we wish you a very merry Christmas and a most prosperous 2012.

“Risk-On, Risk-Off”

It sounds like a play on words, based on the Karate Kid refrain, Wax-On Wax Off, and for all I know it was. Still, I rather like this characterization – coined by a research team at HSBC – of the markets‘ current performance. Moreover, you’ll notice from the placement of that apostrophe that I’m not just talking about forex markets, but about the financial markets in general.

What we mean is that when risk appetite is high, credit markets and equities and high-yielding currencies tend to rally together. When risk appetite fades, “those assets fall and government bonds and safe-haven currencies, including the U.S. dollar, the Swiss franc and, in particular, the Japanese yen rally.” Data from Bloomberg News confirms this phenomenon: “The 120-day negative correlation between Intercontinental Exchange Inc.’s Dollar Index and the Standard & Poor’s 500 Index was at 42.4 percent today, and has been mostly above 40 percent since June 2009.”
Skeptics counter that this correlation is tautological. Anyone can point to a stock market rally and declare that “Risk is Back On.” In addition, it’s not wholly unsurprising that there are strong correlations between low-risk currencies and low-risk assets, and between high-risk currencies and high-risk assets. According to HSBC, however, this time is different.

For example, models suggest that the recent decline in volatility should have caused these relationships to break down. That they defied predictions and remained strong suggests that we have witnessed a significant paradigm shift. In the past, “Rising correlations are also tied to weak macroeconomic conditions.” At the moment, this could hardly be more true, with global economic growth flagging.
Statisticians love to teach the dictum, Correlation does not imply causation. Nonetheless, I think that in this case, I’d wager to say that the equity and credit/bond markets are driving forex, rather than the other way around. Consider as evidence that, “[Retail] Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year,” and shifted this capital into bonds. While this wouldn’t in itself be enough to drive the Dollar higher, it epitomizes the steady shifts that have been taking place in capital markets for nearly a year, broken only by the S&P/Euro rally in the spring (which now appears to have been an aberration).

In fact, these shifts are once again creating shortages of Dollars: “This week, two banks bid at the European Central Bank’s weekly dollar liquidity providing auction – the first time there have been any bids since May – suggesting that they could not raise dollars in the market.” This suggests that demand for the Dollar could continue to grow.
Some analysts have suggested that the low-yielding US Dollar is already on its way to becoming a funding currency for carry traders, but I think this is wishful thinking. The HSBC report supports this conclusion, “A weakening of the ‘risk on-risk off’ paradigm is likely only once macro conditions are improved in a sustainable way…Currency performance will likely be tied to the ebb and flow of the perception of risk for some months to come.” In short, until there is solid proof that the global economy has emerged from recession (even if ironically it is the US which is leading the pack downward), the Dollar will probably remain strong.

Trading In Emerging/Exotic Currencies Increases

The long wait is over! The Bank of International Settlements (BIS) has just released the results from its Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, conducted in April 2010. The report contains a veritable treasure trove of data, perhaps enough to keep analysts busy until the next report is released in 2013. [Chart below courtesy of WSJ].

First, the data confirmed earlier reports that average daily forex volume had surged to a record level in 2010: “Global foreign exchange market turnover was 20% higher in April 2010 than in April 2007, with average daily turnover of $4.0 trillion compared to $3.3 trillion. The increase was driven by the 48% growth in turnover of spot transactions, which represent 37% of foreign exchange market turnover. The increase in turnover of other foreign exchange instruments [consisting mainly of swaps and accounting for the majority of forex trading activity] was more modest at 7%.” In addition, for the first time, investors and financial institutions accounted for a larger share of turnover than banks, whose trading activity has remained roughly unchanged since 2004.

The composition of the turnover actually didn’t change from 2007, interrupting a shift which had been taking place over the previous 10 years. Specifically, the share of overall turnover accounted for by the so-called major currencies actually increased in 2010, from 172% to 175%. [Since there are two currencies in every transaction, total volume sums to 200%]. Growth in the G4 currencies (Dollar, Euro, Pound, Yen) was more modest, however, increasing from 154% to 155%. This reversal is probably attributable to the credit crisis, which drove (and in fact, continues to drive) investors out of emerging market currencies and back into safe haven currencies, namely the Dollar, Yen, and Pound. However, this theory is belied by the significant increase in Euro trading activity, which certainly hasn’t benefited from the recent trend towards risk aversion.

While emerging currencies as a group accounted for a smaller share of overall activity, certain individual currencies managed to increase their respective shares. The Singapore Dollar, Korean Won, New Turkish Lira, and Brazilian Real all fit into this category. Still other currencies, such as the Indonesian Rupiah and Malaysian Ringgit, also managed impressive gains but account for such a small share of volume as to be insignificant when looking at the overall the picture. Those who were expecting even bigger growth should remember that it’s ultimately a numbers game: the amount of Ringgit it outstanding is dwarfed by the number of Dollars, so any gains that the Ringgit can eke out are impressive. In addition, when you consider that the overall forex pie is also increasing, the nominal increase in volume for these small currencies was actually quite large.

The ongoing search for yield in all corners of the financial markets is likely to bring some of the more obscure currencies into the fold. “In June, I began getting questions about Uruguay, Vietnam and others,” said Win Thin, senior currency strategist at Brown Brothers Harriman in New York…investors often asked Mr. Thin questions about less-familiar currencies such as the Ukrainian hryvnia and Romanian leu.” In the same article, however, Mr. Thin cautioned that interest in such currencies is still probably lower than in 2007-2008, for a good reason. “It’s not like the Group of 10, or even the more liquid emerging market currencies where, if you decide you’ve made a mistake, you can get out.”

Due to the lack of liquidity and higher spreads, these obscure currencies aren’t really suitable for trading. Of course there will be a handful of institutional and even retail investors that want to make long-term bets on these currencies. They tend to be more aware of the risk and less sensitive to the higher cost and lower convenience. The overwhelming majority of traders, however, churn their portfolios daily, if not hundreds of times per day. A 10pip spread on the USD/MXN (Dollar/Mexican Peso) would be considered too high, let alone a 50 pip spread on any transaction involving the Ukrainian hryvnia.

In short, the majors will account for the majority of trading volume for the foreseeable future, regardless of what happens to the Euro. At the same time, that won’t prevent a handful of selected emerging currencies, such as the Chinese Yuan, Indian Rupee, Brazilian Real, and Russian Ruble from increasing their share. As liquidity rises and spreads decline, volume will increase, and their rising importance will become self-fulfilling.

Trend is your friend

Raise your hand if you’ve ever heard that expression before? Well, now there’s proof that this well-worn phrase is more than just a pointless platitude: “Royal Bank of Scotland Group indexes that track the performance of four of the most popular currency strategies show that the so-called trend style was the best-performing method, returning 7.3 percent this year through August.”

“Trend-Style” trading is also known as trend-following, and is just as it sounds. Traders identify one-way patterns in specific currency pair(s), and attempt to ride them for as long as possible. Given all of the big movements in currency markets this year, it’s no wonder that trend-following is the most popular. If you look at the 52 week trading ranges for the six most popular USD currency pairs, you can see that highs and lows are often as far as 20% apart. The EUR/USD pair, for example, fell 20% over a mere 7 months. Anyone who sold in December 2009 and bought to cover in June 2010 would have earned an annualized return of 35% without leverage! Even if you had captured only a couple months of depreciation would have yielded impressive returns. In addition, you could have traded the Euro back up from June until August and reaped a 60% annualized return. Best of all, both of these trends (down, then up) unfolded very smoothly, with only minor corrections along the way.

I’m sure serious technical analysts are rolling their eyes at the chart above, but the point stands that trend-following has never been easier and rarely more profitable than it is now. One fund manager summarized, “Trend-following investors are capturing the momentum in several big currency moves. You have so much uncertainty in the world now with regard to inflation or deflation, which typically makes currency markets and interest rates move. That is good for trend followers as it causes volatility, which typically creates good profits.” In other words, there is a tremendous amount happening in forex markets at the moment, and this is reflected in protracted, deep moves in currency pairs, which can change direction without notice and yet continue moving the opposite way for just as long. If you think this sounds obvious, look at historical data (5-10 years) for the majority of currency pairs: while trends have always been abundant, it was only recently that they began to last longer and became more pronounced.

The other three strategies surveyed by the Royal Scotland Group (“RSG”) were the Carry Trade, Value Trade, and Volatility Trade. Unfortunately, data was only offered for the carry trade strategy (confusingly referred to by RSG as the volatility strategy), which is down 5.9% in the year-to-date. The carry trade strategy involves selling a currency with a low yield and favor of one with a high yield, and profiting from the interest rate spread. In order for this strategy to be profitable, however, the long currency must either appreciate or remain constant. Thus, when volatility is high – as it has been over the last 2-3 years – this is a losing strategy.

We can only guess that a true volatility strategy probably would have been the second most profitable strategy. This strategy can be implemented through the use of long and short spot positions, as well as through trading in options and other derivatives. As I said, there is no shortage of volatility at the moment: “Since the collapse of Lehman Brothers in 2008, the dollar has seen record volatility against the euro…including six moves of at least 10%.” For traders that profit from volatility, the current uncertainty has created a windfall situation.

However, it has made value trading – based on fundamentals and the notion of Purchasing Power Parity (PPP) – risky and unpopular: “The volatility also has made what would appear to be a straightforward bet against the dollar fraught with risk. Three factors tend to move currencies: the pace of growth, debt levels and interest rates. By those standards, the dollar should be falling against the currencies of emerging-market and commodity-producing nations.” Not only is this not the case (a decline in risk appetite has turned the Dollar into a safe-haven), but even betting on a protracted Dollar decline is itself risky because of surging volatility. One way around this is to trade a Dollar Index (by way of an ETF, for example) which is inherently less volatile (half as volatile, to be exact) than individual currency pairs.

That’s not to say that value trading isn’t profitable over the long-term. “Empirical evidence suggests that currencies…show a tendency to revert back toward PPP in the longer run.” Given current volatility/uncertainty, however, this strategy is unlikely to be profitable in the short run. Fortunately, uncertainty doesn’t negate opportunity, and traders should plot strategy accordingly.

CFTC / NFA Enhance Regulation of Forex

In 2010, the US Commodity Future Trading Commission (CFTC) formally released a series of new regulations governing all retail foreign exchange dealers. Having given all applicable firms almost six months to bring their operations up to speed with the new regulations, the CFTC is now moving to bring enforcement actions against those that are still not in compliance.
Among other things, the regulations required all retail forex broker-dealers to register accordingly with the National Futures Association (NFA), and for firms that “solicit orders, exercise discretionary trading authority or operate pools with respect to retail forex” to register as introducing brokers. Out of curiosity, I scoured the NFA Background Affiliation Status Information Center (BASIC) to see if/how forex brokers have registered themselves.

As you can see from the table above, there are approximately [I would be grateful if you could inform me of any known omissions!] 28 registered forex firms, and the CFTC recommends that (US) retail forex traders that manage their own accounts should deal with these firms exclusively.
Unfortunately, many firms continue to advertise that themselves as forex brokers when they aren’t registered as such, or even worse, aren’t registered at all. As a result, the CFTC recently filed simultaneous enforcement actions against 14 forex firms, alleging that, “In all but two of the complaints…a defendant acted as an RFED; that is, it offered to take or took the opposite side of a customer’s forex transaction without being registered. In the remaining two complaints, ZtradeFX LLC and FXPRICE, the CFTC alleges that the defendant solicited customers to place forex trades at an RFED without being registered as an Introducing Broker.” The following companies stand accused:

To be a fair, NFA membership doesn’t necessarily imply compliance with NFA regulations, nor does it even guarantee upright behavior. In fact, the NFA is currently scrutinizing all of its member firms “for any signs they are designing computer systems to take advantage of what is known in the industry as ‘slippage,’ or small price movements that happen between the time a customer orders a trade and when that trade is actually executed.” In October, the NFA settled two such cases with IKON FX and Gain Capital, assessing a combined $800,000 in fines. Let’s hope that this isn’t the real explanation for the fact that forex trading is vastly more profitable for brokerages than other types of retail securities trading.
While the NFA hasn’t indicated that this is the case, the current retail forex MO (whereby brokers also act as market-makers) could be under attack. As one advocate for traders told the WSJ, “If a foreign-exchange firm is acting as a market-maker, or taking the other side of a client’s trades, it is doubtful the investor is getting the best possible price.” The problem is at the moment, the industry remains far from transparent, and if not for the NFA investigations, traders probably wouldn’t be able to establish whether their broker(s) acted unscrupulously.

Hedging High Forex Uncertainty

In forex, everything is relative. That is no less the case for forex volatility, which is low relative to the spikes in 2008 (credit crisis) and 2010 (EU Sovereign debt crisis), but high relative to the preceding 5+ years of stability. On the one hand, volatility is approaching a two year low. On the other hand, analysts continue to warn of high volatility for the foreseeable future. Under these conditions, what are (currency) investors supposed to do?!
Despite the steady pickup in risk appetite in 2010, there remains a whole a host of forex risk factors. On the economic front, GDP growth remains anemic in western countries, unemployment is high, and consumer confidence is low. Budget deficits and national debts are rising, perhaps to the point that default by a major industrialized countries is inevitable. Emerging market countries seem to be ‘suffering’ from the opposite problem, whereby rapid growth, high commodities prices, and capital inflow has caused inflation to rise precipitously. Some Central Banks will be forced to hike interest rates, while others will try to maintain an easy monetary policy for as long as possible. Political crises flare-up without warning, the Euro risks breaking up, and inclement weather is wreaking havoc on food production.

As a result, most currency-market watchers expect 2011 to be a continuation of 2010. In other words, while we might be spared a major crisis, a generalized sense of uncertainty will continue to pervade forex. According to JP Morgan, “Implied volatility on options for major exchange rates averaged 12.34 percent this year, compared with an average of 10.6 percent since January 2000.”  The currency team of UBS predicts, “The divergence between the strength in emerging markets and the unusual levels of uncertainty in the world’s major economies will cause…super volatility,” whereby massive swings in exchange rates will become the norm.
In this environment, there are a number of things that currency traders should do. The first step is simply to be aware that volatility remains high, which means that wider-than-average fluctuations shouldn’t be a surprise. The next step is to decide whether you think that this volatility will remain at an elevated level for the near-term, or whether you expect it to continue declining. (It’s worth pointing out that volatility is not necessarily a perception of absolute risk, but investor perception of risk). The final step is deciding if/how you will tailor your trading strategy in response to changes in volatility.
In fact, you don’t necessarily need to limit your exposure to volatility. If you are a fundamental investor with a long-term approach, you may very well choose to write-off short-term fluctuations as noise. (Of course, if you are a short-term swing trader, you can’t afford to be quite so indifferent). In addition, if your primary interest is in another asset type, you may choose not to hedge any currency risk. Perhaps you believe that the base currency will continue appreciated and/or you relish the exposure to currency movements as an added benefit of asset price exposure. Along these lines, “During the planning stages of the UBS Emerging Markets Equity Income fund, UBS Global Asset Management considered offering investors a hedged share class. The team abandoned the idea when investors showed a preference for unhedged share classes.”
In addition, hedging currency risk is expensive, especially for exotic/illiquid currencies, and currencies characterized by above average volatility. Not to mention that currency hedges can still move against investors, resulting in heavy losses. Still, in 2010, “Corporations from the U.S., Japan and Europe increased the percentage of projected income protected against swings in exchange rates to a record,” which suggests that fear of adverse exchange rate movements still predominates.
Finally, there are those that want to construct second-order currency strategies based entirely on volatility. Using basic options techniques, such as spreads and straddles, it’s possible to profit from volatility (or lack thereof) regardless of which direction the underlying currencies move in. In fact, the CME Group recently introduced a new product series which seeks to perform this very function. Investors can already buy and sell futures based on short-term volatility in the EUR/USD, which will soon be replicated for all of the major currency pairs.

For those of you who like to keep it simple, it’s probably enough to monitor the JP Morgan G7 Currency Volatility Index, which is a good proxy for the risk associated with trading (major) currencies at any given time. When this index spikes, chances are the US Dollar and other safe haven currencies will follow suit.

Forex Volatility Rises from Multi-Year Lows

In the last month, volatility in the forex markets touched both a two-year low and a one-year high. In the beginning of March, volatility essentially returned to pre-credit crisis levels. One week later, when the earthquake and inception of the nuclear crisis in Japan, volatility surged 40%. While it has since resumed its downward path, investors are still bracing themselves for continued uncertainty.

The carry trade has perhaps born the brunt of the volatility spike. The carry trade depends on interest rate differentials – as opposed to currency appreciation – to drive profits, and  thus demands stability. When the markets become choppy and exchange rates spike wildly in one direction or another, it makes the carry trade significantly more risky. Hence the paradoxical rise of the Japanese Yen to a record high following a series of crushing disasters, as highly leveraged traders moved to unwind their Yen-short carry trades.

Likewise, high volatility should spur demand for so-called safe haven currencies. If only it were clear what constitutes a safe haven currency. Traditionally, that would send the US Dollar, Swiss Franc, and Japanese Yen upwards. In this case, the Franc has benefited most, followed closely by the Yen. The Dollar spiked against emerging market and high-risk currencies, but hardly budged against its G4 counterparts. Could it be that the Dollar’s multi-year positive correlation with volatility has (temporarily?) abated.
With regard to strategy, currency traders have a handful of choices. If you believe that volatility will continue declining or remain stable, you’re probably going to go long emerging market and high-yielding currencies, and short one of the safe-haven currencies, all of which are quite cheap to borrow. The main risk of such a strategy, of course, is that volatility will once again spike, in which these safe have currencies will rally.

If you think that the ebb and volatility isn’t sustainable, then you’re probably going to bet on the Franc, Dollar, or Yen. As I wrote in an earlier post, I think the Yen could theoretically appreciate in the short-term, but actually remains quite risky over the long-term. Despite the best efforts of the Swiss National Bank, the Franc will probably continue appreciation. Economically and monetarily, it is in an excellent shape. Besides, the fact that the supply of Francs is intrinsically small means that even modest capital inflow often translates into a big jump in its its value. As for the Dollar, it is now the most popular currency to short. It remains a safe choice and a good store of value, but probably won’t deliver the returns that safe-haven strategists have come to expect.
From a practical standpoint, you may also want to consider reducing your leverage. As everyone knows, high leverage increases profits but also magnifies losses. In the current environment of heightened volatility, leverage also magnifies risk. Either way, you may also want to consider hedging your exposure, by trading a basket of currencies and/or through the use of options.

Retail Forex: Lower Corporate Profits = Lower Spreads for Traders?

In December 2010, both GAIN Capital and FXCM became public companies. This was thought both to signal the maturing of an industry and to herald the start of a period of explosive growth. Since then, the share prices for both companies have fallen dramatically, even while the S&P 500 has continued to rise. Trading volume has remained flat, and revenues have declined. As a result, analysts (myself included) are starting to question not only the operations of these two firms, but also of the entire industry.
Before we jump to conclusions, it’s important to understand the basis for this sudden aura of uncertainty . First of all, both firms – as well as the broader forex industry – have found themselves the subject of increased regulatory scrutiny, and consequent disciplinary action. Second, trading volume has been impacted by an uptick in volatility. Third, an increase in institutional trading volume has not translated into a proportional increase in revenues/profits. Fourth, the recent tightening of leverage rules (which may be helping traders!) has eroded a large profit center. Finally, high account turnover suggests that the brokers will eventually run out of customers.
I don’t want to dwell on the industry’s regulatory travails (since I have blogged about it before), except to say that I think it’s a good thing. It will bring greater transparency, and generally make trading safer and cheaper. For more information on the specific allegations and (potential) regulatory response, the WSJ recently published an excellent overview.

As for the temporary decline in retail trading volume, this is probably temporary. Overall forex volume has tripled over the last decade, and it is forecast to triple again over the coming decade. In addition, the mainstreaming of currency trading will spur millions of investors to at least dabble on forex. Unfortunately, this will probably be offset by a decline in trading activity by existing customers, as the majority come to terms with the difficulty of profiting through high-volume/high-leverage trading.
Furthermore, increased volume will combine with increased competition to facilitate lower spreads. According to a recent report by LeapRate, GAIN Capital now earns an average of only 1.7 pips per trade, a stunning drop for the 2.7 pips that it averaged during most of 2010. Basically, the same thing is now happening to forex that decimalization and computerization brought to bear on stocks. If hedge funds and other institutional traders continue to enter the market en masse, spreads will be arbitraged away to the point that 1-2 pips (or even smaller!) should become the norm for all major currency pairs.

In short, retail forex traders should applaud the decline in stock prices. After all, what’s good for traders is probably going to be bad for business. Liquidity is increasing, and spreads are falling. Enhanced regulation is eliminating shadowy sources of profit and will make trading more secure. The only thing left to hope for is that all forex brokers go public, and open up their books to the same level of scrutiny as GAIN Capital and FXCM.

Icelandic Kronur: Lessons from a Failed Carry Trade

A little more than two years ago, the Icelandic Kronur was one of the hottest currencies in the world. Thanks to a benchmark interest rate of 18%, the Kronur had particular appeal for carry traders, who worried not about the inherent risks of such a strategy. Shortly thereafter, the Kronur (as well as Iceland’s economy and banking sector) came crashing down, and many traders were wiped out. Now that a couple of years have passed, it’s probably worth reflecting on this turn of events.

At its peak, nominal GDP was a relatively modest $20 Billion, sandwiched between Nepal and Turkmenistan in the global GDP rankings. Its population is only 300,000, its current account has been mired in persistent deficit, and its Central Bank boasts a mere $8 Billion in foreign exchange reserves. That being the case, why did investors flock to Iceland and not Turkmenistan?
The short answer to that question is interest rates. As I said, Iceland’s benchmark interest rate exceeded 18% at its peak. There are plenty of countries that offered similarly high interest rates, but Iceland was somehow perceived as being more stable. While it didn’t apply to join the European Union (its application is still pending) until last year, Iceland has always benefited from its association with Europe in general, and Scandinavia in particular. Thanks to per capita GDP of $38,000 per person, its reputation as a stable, advanced economy was not unwarranted.
On the other hand, Iceland has always struggled with high inflation, which means its interest rates were never very high in real terms. In addition, the deregulation of its financial sector opened the door for its banks to take huge risks with deposits. Basically, depositors – many from outside the country – parked their savings in Icelandic banks, which turned around and invested the money in high-yield / high-risk ventures. When the credit crisis struck, its banks were quickly wiped out, and the government chose not to follow in the footsteps of other governments and bail them out.

Moreover, it doesn’t look like Iceland will regain its luster any time soon. Its economy has shrunk by 40% over the last two years, and one prominent economist has estimated that it will take 7-10 years for it to fully recover. Unemployment and inflation remain high even though interest rates have been cut to 4.25% – a record low. The Kronur has lost 50% of its value against the Dollar and the Euro, the stock market has been decimated, and the recent decision to not remunerate Dutch and British insurance companies that lost money in Iceland’s crash will only serve to further spook foreign investors. In short, while the Kronur will probably recover some of its value over the next few years (aided by the possibility of joining the Euro), it probably won’t find itself on the radar screens of carry traders anytime soon.

In hindsight, Iceland’s economy was an accident waiting to happen, and the global financial crisis only magnified the problem. With Iceland – as well as a dozen other currencies and securities – investors believed they had found the proverbial free lunch. After all, where else could you earn an 18% by putting money in a savings account? Never mind that inflation was just as high; with the Kronur rising, carry traders felt assured that they would make a tidy profit on any funds deposited in Iceland.

The collapse of the Kronur, however, has shown us that the carry trade is anything but risk-free. In fact, 18% is more than what lenders to Greece and Ireland can expect to earn, which means that it is ultimately a very risky investment. In this case, the 18% that was being paid to depositors were generated by making very risky investments. As the negotiations with the insurance companies have revealed, depositors had nothing protecting them from bank failure, which is ultimately what happened.
Now that the carry trade is making a comeback, it’s probably a good time to take a step back and re-assess the risks of such a strategy. Even if Iceland proves to be an extreme case – since most countries won’t let their banks fail – traders must still acknowledge the possibility of massive currency depreciation. In other words, even if the deposits themselves are guaranteed, there is an ever-present risk that converting that deposit back into one’s home currency will result in losses. That’s especially true for a currency that is as illiquid as the Kronur (so illiquid that it took me a while to even find a reliable quote!), and is susceptible to liquidity crunches and short squeezes.

When you enter into a carry trade, understand that a spike in volatility could wipe out all of your profits in one session. The only way to minimize your risk is to hedge your exposure.

Are Forex Markets Underpricing Volatility?

This question has been raised by several market commentators, including The Wall Street Journal. Its recent analysis, entitled “Currency Investors: What, Me Worry?” wondered whether the forex markets might not have become too complacent about risk and have seriously underestimated the possibility of another shock.

First, some basics. There are two principal volatility measurements: implied

volatility and realized volatility. The former is so-called because it must be deduced indirectly. In the Black-Scholes model for pricing options, volatility is the only unknown variable and thus is implied by current market prices. It serves as a proxy for investor expectations for volatility over the period for which the option is valid. Realized volatility is of course the actual volatility that is observed in currency markets, calculated based on the size of fluctuations over a given period of time. When fluctuations are greater (whether upward or downward), volatility is said to be high.

 

For short time frames, implied volatility tends to be very close to realized volatility. For longer time-frames, however, this is not necessarily the case: “The long-dated implied volatilities are often driven to extreme values by one-sided demand or supply – the difference between implied and realised volatilities this causes is particularly large during periods of risk aversion in the market…making implied volatility a particularly poor proxy for realised volatility during periods of market unrest.” In practice, this is reflected by higher prices for long-dated put or call options (depending on the direction of the move that investors are trying to hedge against).

 

Indeed, most volatility metrics are well below their historical averages and are rapidly closing in on pre-credit crisis levels. This is true for the JP Morgan G7 3-month forex volatility index, the S&P VIX, as well as for specific currencies. Mataf.net (whose content manager I interviewed yesterday) contains replete short-term and long-term data for a few dozen currency pairs, and you can see that almost all of them feature the same downward trend. According to the WSJ, “Investors believe there is a 66% chance each day for the next month that the euro and pound will move no more than 0.6% and 0.5%, respectively—both limited moves.” In addition, “A gauge of the euro’s ‘realized’ volatility, which measures how much daily changes deviate from their recent average, is only 8.6%, lower than its 11% rolling one-year average.”

Of course, some commentators don’t see any problem here. They see it both as a positive indication that the markets have returned to normal following the financial crisis, and as a reflection of the correlation that has developed between stock prices and forex markets. (You can see from the chart below the strong inverse correlation between the S&P and the US dollar). According to Deutsche Bank, “Most news that should have shocked the market this year has not managed to do so for sufficiently long to make volatility rise sustainably. Our analytical models tell us that we are indeed moving to a low volatility environment again.”

 

On the other side of the debate is a growing consensus of investors that sees a pendulum that has swung too far. “I just don’t see how volatility will not increase quite substantially,” said one money manager. “There is significant potential for shocks to the system that currency volatility levels suggest the market is not prepared for,” added another, citing higher commodities prices and inflation, growing public debt, and the imminent end of the Fed’s QE2 monetary stimulus.

 

To be sure, volatility has started to tick up over the last month. This trend has also been reflected in options prices: “Many investors have avoided buying short-dated currency options this year, instead focusing on longer-dated protection, a phenomenon called a ‘steep volatility curve’…that trend has slowed a bit, with investors moving to hedge against near-term yen, euro and dollar swings.”

 

Currency traders should start to think about making a few adjustments. Those that think that volatility will continue to rise and/or that the markets are currently underpricing risk can employ a volatility strangle strategy, buying way out-of-the-money puts and calls. The options will pay off if there is a big move in either direction, with no downside risk. Those that think that volatility will continue declining or at least remain at current low levels can make use of the carry trade. Those pairs where interest rate differentials are highest and volatility levels are lowest represent the best candidates. BNP Paribas is also reportedly developing a product that will make it easier for traders to make volatility bets without having to rely on indirect means.