Self-fulfilling and self-destructing FX carry trades

November 2, 2014

When foreign exchange trading meets inflation-targeting self-fulfilling investment strategies are possible. A technical paper by Plantin and Shin shows that positive FX carry encourages capital inflows that reduce inflation and allow monetary policy to condone a domestic asset market boom. Thereby FX carry strategies create their own implicit subsidy and self-validating flows. Conversely, a reversal of such flows is self-destructing.

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Disaster risk and currency returns

November 1, 2014

A paper by Farhi and Gabaix explains how fear of global crisis leads to outperformance of risky versus less risky currencies. Carry trades have worked historically, because high risk premia conditioned both high interest rates and subsequent revaluation. As a practical conclusion, gaps between perceived risk (often based on historical variances and correlation) and actual fundamental risk (as indicated by fundamental macro factors) are key value generators in FX strategies.

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Volatility surprises

October 12, 2014

Volatility surprises are market moves outside the scope of expected volatility. They often bring to attention an underestimated type of risk. A paper by Aboura and Chevallier suggests that these volatility surprises transmit more easily across markets than return shocks. Moreover, the arising of unpredicted risk across markets seems to be cumulative.

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The pitfalls of emerging markets asset management

October 4, 2014

Dedicated EM exposure has surged by over 55% since 2007, with assets concentrated on few managers. A new BIS article points out that trading flows are correlated due to the widespread use of benchmarks. Moreover, EM asset prices and final investor flows have been pro-cyclical and mutually reinforcing. These patterns seem conducive to recurrent market dislocations.

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Macroeconomic news and bond price trends

September 27, 2014

A new paper estimates that U.S. economic data explain more than a third of bond price fluctuations on a quarterly basis. The economic data impact on daily fluctuations is much weaker. It grows with the time horizon because economic factors are more persistent than non-fundamental factors. The simple powerful message is that economic news flow is crucial (and probably underestimated) for identifying market trends.

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Understanding convenience yields

September 20, 2014

Convenience yield represents the implied interest paid for borrowing physical commodity. Holding physical inventories carries benefits of flexibility for industrial consumers. The value of such inventories increases when scarcities arise. As a consequence, convenience yields help predicting future demand and price changes. A new Bank of Canada paper illustrates this for the crude oil market.

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The asymmetry of government bond returns

August 31, 2014

Developed market government bonds are viewed as “safe havens”, but in reality they have been prone to sudden outsized price declines, similar to FX carry trades, even during the past 20 years of modest inflation. Drawdowns are worse in poor liquidity. This empirical finding is not new but more relevant as bond yields have been compressed and institutional duration exposure has surged relative to banks’ market making capacity.

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Combining fundamentals- and momentum-based equity strategies

August 30, 2014

A University of York paper suggests that equity strategies based on fundamentals and strategies based on momentum are complementary. Thus, relative momentum seems to be a useful overlay for earnings growth-oriented portfolios (probably detecting when high growth companies hit a snag). And trend following has historically reduced volatility and drawdowns of both value and growth strategies.

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Origins of financial market trends

July 27, 2014

A working paper explores sources of market price trends. It suggests that small trend changes in perceptions about “fundamentals” can set in motion a persistent adjustment in transacted prices. And even without any changes to “fundamentals” or “technicals” trends are plausible.

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Volatility markets: a practitioner’s view

July 6, 2014

Christopher Cole argues that volatility markets are about trading both known and unknown risks. These risks require different pricing and cause different “crashes”. Most portfolio managers either hold implicit short volatility or long volatility positions. After the great financial crisis, monetary policy has suppressed volatility, but steep volatility curves are indicating a “bull market in fear”.

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asset management Asset Purchase Program banks bond returns bond yields bubbles capital regulation carry China collateral commodities credit returns default ECB economic data EM equity returns euro area crisis Fed financial crisis FX FX interventions FX returns government debt government deficits herding inflation information insurances Japan leverage liquidity machine learning market turmoil price factors regulation risk management shadow banking statistical methods term structure trend following variance risk premium VIX volatility ZLB
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Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.

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