FX carry trade crashes

March 25, 2017

A global historical analysis of FX carry trades shows positive long-term performance but a negative skew of returns. Large drawdowns have been associated with global financial stress. This supports the view that FX carry returns are to some extent a premium for undiversifiable risk. FX carry trade crashes have been diverse in duration and size, exceeding 2 years and 30% in extreme episodes. Historically, high carry and positive valuation metrics have shortened the duration of sell-offs in FX carry portfolios. Financial stress in the developed world has prolonged the duration of drawdowns of developed market FX carry trades.

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Debt-weighted exchange rates

January 28, 2017

Trade-weighted exchange rates help assessing the impact of past currency depreciation on economic growth through the external trade channel. Debt-weighted exchange rates help assessing the impact of past currency depreciation on economic growth through the financial channel. Since these effects are usually opposite looking at both simultaneously is crucial for using exchange rate changes as a predictor of economic and local market performance. For example, as a consequence of the financial channel many EM economies fail to benefit from currency depreciation in the way that small developed economies do.

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The risk-adjusted covered interest parity

October 22, 2016

The conventional covered interest rate parity has failed in modern FX markets. A new HKIMR paper suggests that this is not a failure of markets or principles, but a failure to adjust the parity correctly for relative counterparty and liquidity risk across currency areas. Specifically, FX swap rates deviate from relative money market rates due to counterparty risk and from relative risk free (OIS) rates due to liquidity risk. Correct adjustment helps to detect true FX market dislocations.

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Fed policy shocks and foreign currency risk premia

August 5, 2016

A new Federal Reserve paper suggests that non-conventional monetary policy easing “shocks” not only push foreign currencies higher versus the U.S. dollar, but also reduce the risk premia on foreign-currency cash and bonds. Non-conventional easing shifts the options-implied skewness of risk from dollar appreciation to depreciation, due partly to diminishing U.S. dollar funding pressure. The effects appear to be temporary, though.

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FX strategies based on real exchange rates

July 9, 2016

New empirical research provides guidance as to how to use real exchange rates for currency strategies. First, real exchange rates can serve as a basis for value-based strategies, but only if they are adjusted for key secular structural factors, such as productivity growth and product quality. Second, real exchange rates in conjunction with macroeconomic indicators can serve as indicators for the risk premia paid on currency positions.

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Why the covered interest parity is breaking down

June 18, 2016

Deviations in the covered interest parity have become a regular phenomenon even in developed markets. Persistent gaps between on-shore and FX-implied interest rate differentials (“cross-currency basis”) can be explained by the combination of increased cost of financial intermediation in the wake of regulatory reform and global imbalances in investment demand and funding supply. They can offer information value and arbitrage opportunities for investors.

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Understanding market beta in FX

May 25, 2016

The beta of an investment measures its sensitivity to “market returns”. Unlike in equity, in FX the relevant benchmark for a beta cannot be a long-only index. Instead, an FX-specific beta can be based on common types of currency strategies, such as carry and trend. Currency betas measured against such benchmarks can be valuable for portfolio construction and measuring positioning risk.

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Using commodity prices to predict exchange rates

April 9, 2016

A new empirical study confirms that export price changes explain a substantial part of commodity currency fluctuations, particularly at high frequencies. More importantly, country-specific export price indices help predicting commodity countries’ future exchange rate dynamics. The predictive power appears to be most robust over a horizon of one month.

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EM exchange rates and self-reinforcing trends

February 6, 2016

Emerging market exchange rates can be catalysts of self-reinforcing trends. Currency appreciation raises both global lenders’ risk limits and EM institutions’ debt servicing capacity. Currency depreciation spurs the reverse dynamics. Their escalatory potential constrains central banks’ tolerance for exchange rate flexibility.

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How current accounts mislead FX markets

October 31, 2015

A common fallacy is that current account deficits measure dependence on external financing. In reality, external balances and cross border financing are only vaguely related. Vulnerability to “stops” in financial flows does not depend on trade and capital flows (“net concept”) but only on the volume and origin of financing (“gross concept”). Currency crises are not about current accounts that need to adjust, but about funding gaps that need to be closed.

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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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