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OTC Partners FX subject matter expert Sol Steinberg commits his experience in the institutional FX industry toward specializing in market intelligence.
Based in New York, he is the Founding Principal of OTC Partners, a boutique research firm which focuses on commercial development, strategic analysis and research for the OTC derivative industry.
At the FXIC conference in New York City hosted by Shift Forex recently, LeapRate discussed many aspects of the landscape that lies ahead with Mr. Steinberg, who takes a close look at time period between the next few months and the next five years ahead in this guest editorial.
Mr. Steinberg spent two years as VP at LCH.Clearnet before founding OTC Partners, and has a great deal of experience in risk management with companies including Citco Fund Services, Citi, Fintech and the MONY Group dating back to 2002, and was educated at New York University Stern School of Business, where he is a Risk Management fellow, as well as having obtained a BSc in Finance, Banking and Economics from Northeastern University.
Investors have been exposed to a 7 year bull market in equities, while that has been great for their portfolios, the length of the run is now creating concerns about a coming correction. In the US much of this bull market has been supported by the activities of the Federal Reserve pushing stimulus plans for the market.
Now, other central banks the world over are following suit as easing comes to a close here at home. This activity, and the impact it will have on currencies is making FX investing relevant once again.
To be successful, investors will need to look closely at global economies, and global currencies to determine which spots will be the most effective for hedging programs, and which to invest in without a hedge.
The divergence between central bank policies is likely to drive the investing agenda around FX over the next five years. For investors that have been involved in the US market, quantitative easing effectively put stimulus into the market that allowed businesses to refinance at very low rates, increase dividend payouts, and start doing stock buyback programs. These efforts were beneficial to equities investors and led the bull market for the past seven years.
Now, the Fed has indicated that it sees enough relative strength in the US economy to move toward raising rates slightly. Most players agree this is likely to happen either in Q3 or Q4 of this year.
Against that backdrop, other areas like the EU and China are just beginning stimulus policies of their own. This creates a diversion in currency strength as well as forecasts for the equities markets in those countries. The ECB has begun its bond buying program.
That program is expected to last through 2016. As we have seen recently, a significant portion of the EU is in a negative yield environment.
The most high profile example of this is German Bunds which were at 5bps at times over the past two months before recovering slightly to where they are now. This situation is more likely to push investors into US dollar bonds as they provide at least a two percent yield over the negative yield environment of the EU. We are also in the early stages of a strong dollar cycle, which will provide a stronger opportunity set for currency investors.
The Euro, on the other hand, will weaken as the stimulus coming from the ECB makes it into the market. The Euro is expected to go to 1.05 or even as low as dollar parity over this process. Given that, it makes sense to maintain a hedged Euro call. Negative yields will also make European equities more attractive, as with negative yields European bond investors would essentially be paying the government to take their money.
Japan, like the US is further along in its stimulus experiment. Given that, we are likely to be past the point where the Yen will take any more big hits. In this environment an unhedged currency call for the Yen makes more sense. The Yen already declined 50% from 2012-14, and we’ve started to see a move toward a slightly stronger currency in recent months. There is also a great case for Japanese equities in this environment as earnings strength is driving returns in Japan.
Of the developed markets, Japanese equities remain the most attractive from a price to earnings ratio. Shareholders have also seen increases in dividends and share buyback programs and that trend is likely to continue as a benefit to stocks.
The reallocation recently announced by Japan’s trillion dollar GPIF pension doubling its exposure to Japanese equities is another high profile example of the pent up demand for Japanese stocks. Other Japanese pensions have indicated their plans to follow suit as well.
How do investors determine when to put on a hedged currency call? Most recently, ETFs have emerged as the easiest and most liquid avenue for this. We’ve seen ETFs gather $35 billion in AUM YTD as a testament to the strength of these instruments.
The primary consideration an investor wants to make in terms of whether to hedge a currency is investment timeline coupled coupled with their view of the dollar. An unhedged currency call will expose you to all of the embedded risks in a currency, whereas a hedged call will mitigate that risk. Investors that see a currency gaining strength relative to its history and to the dollar, may want an unhedged call for example, if they are prepared to take on that risk.
ETFs also allow investors to dial the risk up or down, again, depending on time horizon. Investors who were 100% hedged on the Euro for example, are likely to see positive returns over the next year, whereas those with an unhedged call are likely to see negative returns over the year. Pairing hedged and unhedged currency ETFs can be a low cost way to improve currency exposures.
This is a guest editorial which was compiled by, and represents the views of Sol Steinberg, Founding Principal, OTC Partners