Tags: federal reserve | default | stimulus | economy

Fed Relegates Default to Sideshow as Volatility Ebbs

Wednesday, 16 October 2013 07:22 AM

In the world’s largest market, the potential for a U.S. default is proving to be a distraction to what really matters: whether the Federal Reserve will maintain its extraordinary monetary stimulus.

The JPMorgan Chase & Co. index that measures price swings in the $5.3 trillion-a-day foreign-exchange market has tumbled rather than increase as the Oct. 17 deadline approaches for when U.S. borrowing authority lapses. The New York-based firm’s Global FX Volatility Index slid to 8.30 percent yesterday, the lowest level since January and down from a one-year high of 11.96 percent in June.

The drop in volatility underscores how the Fed’s grip on asset prices around the globe is only getting tighter as it pumps $85 billion a month into the financial system by buying bonds. The longer the U.S. government remains shut and the possibility of default rises, the less likely the central bank will taper its purchases anytime soon.

“Markets have been gaining comfort from the assumption that the Fed will probably delay tapering,” Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, said in a phone interview. “Volatility has remained low, so there’s a positive environment for investors to return to higher-yielding currencies.”

Carry Trade

While the government is publishing only limited economic data during the shutdown, the Federal Reserve Bank of New York said that its general economic index for New York, northern New Jersey and southern Connecticut fell to 1.5 for October, a five-month low, from 6.3 in September. The median estimate in a Bloomberg survey of economists called for a reading of 7.

Muted price swings benefit traders who borrow cheaply in countries with low interest rates, and use the proceeds to buy currencies of economies with higher-yielding assets in what is known as the carry trade. UBS AG’s V24 Carry Index climbed 2.8 percent this month, adding to September’s 1.8 percent gain that was the first in four months.

The U.S.’s AAA credit grade was placed on rating watch negative yesterday by Fitch Ratings, which cited the government’s failure to raise its borrowing limit as the Treasury Department’s deadline nears. Senate talks aimed at ending the government shutdown and preventing a default were on hold yesterday afternoon in Washington as the House considers its competing plan.

Government Shutdown

The $16.7 trillion debt ceiling is due to expire Oct. 17, while a dispute over funding President Barack Obama’s health reforms has kept some government offices shuttered all month.

The U.S. government shutdown has prompted two out of five Americans to curb spending, according to a survey of 1,025 commissioned by Goldman Sachs Group Inc. and conducted Oct. 10-13. Directors at the Fed’s district banks said last month the U.S. economy was expanding at a “moderate” pace, though fiscal “uncertainties” and higher interest rates remained risks to the outlook, minutes showed.

A one-week partial U.S. government shutdown would trim 0.1 percentage point from economic growth, according to the median estimate of economists surveyed by Bloomberg. The crisis may also encourage policy makers to delay lifting the zero-to-0.25 percent target interest rate.

Fed Chairman Ben S. Bernanke announced Sept. 18 the central bank wouldn’t reduce bond purchases without evidence of a more sustained improvement in the U.S. economy. JPMorgan’s volatility gauge dropped 4 percent that day to the lowest in four months.

Broken Tools

“Markets are being manipulated by central banks, and so the traditional tools you would use to predict forex markets don’t work as well,” Richard Falkenhall, a strategist at SEB AB, said in a phone interview from Stockholm. “Investors expected the Fed to wind down their purchases, but now it seems like they’ll carry on for longer.”

Realized volatility for the euro against the dollar, a measure of historical price swings, fell to 6.46 percent, the lowest level since Bloomberg began collating the data in May 2007 and down from 9.18 percent on May 3.

“With what’s going on in Washington right now, you’d think we’d be creating volatility,” Eric Viloria, a senior currency strategist at Gain Capital Group LLC in New York, said in a phone interview. “But taking a look at the context of monetary policy, it’s just going to delay tapering.”

Recoup Losses

Carry trades may offer traders an opportunity to recoup some of the losses they suffered earlier this year.

The Parker Global Strategies LLC Currency Manager Index, which tracks returns of foreign-exchange strategies, slid for a sixth month in September, the longest run of losses since the data were first collated in 2001. The index dropped to 154.66 on Sept. 30, from a high for this year of 165.14 in March, data compiled by Bloomberg show.

FX Concepts LLC, the firm founded by John Taylor and whose $12 billion in assets in 2009 made it the world’s largest currency hedge fund, said this week it’s closing its investment- management business because of difficult currency markets.

“If, during the lame-duck period at the Fed, volatility stays low, one could see carry trades becoming popular,” Stephen Jen, the co-founder of hedge fund SLJ Macro Partners LLP in London and former head of foreign-exchange strategy at Morgan Stanley, said in an e-mail. “This might be a two- month play, because the Fed will have to taper later if not sooner.”

Real’s Returns

Buying the Brazilian real by selling dollars handed investors a 5.4 percent return the past month, making it the most lucrative trade among 31 major currencies tracked by Bloomberg. The trade lost 8 percent in the second quarter.

Investors purchasing Malaysia’s ringgit received 4.5 percent, after losing 1.3 percent from April to June, while India’s rupee made 3.5 percent, following a 6.7 percent loss in the previous period, data compiled by Bloomberg show.

UBS’s V24 Carry Index, which tracks positions in 24 currencies through the forwards market, climbed to 436.94 yesterday, the highest level since July 29 and up from a seven- year low of 417.32 on Sept. 5. Its 4.3 percent third-quarter loss was the biggest since it plunged 11 percent in the three months to September 2011, data compiled by Bloomberg show.

“If we get past the next couple of days, with core rates close to zero, that could support carry trades,” Dan Dorrow, the head of research at Faros Trading LLC in Stamford, Connecticut, said in a phone interview. He recommends buying the Chilean peso against the greenback and Russia’s ruble versus the Canadian dollar. “Volatility will probably stay at current levels or possibly lower.”

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In the world's largest market, the potential for a U.S. default is proving to be a distraction to what really matters: whether the Federal Reserve will maintain its extraordinary monetary stimulus.
federal reserve,default,stimulus,economy
Wednesday, 16 October 2013 07:22 AM
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