The Trader’s Grin That Tells You Volatility Is Back: Currencies

By Lucy Meakin and Eshe Nelson

Currency traders preparing to square their books before the end of the year are looking forward to their first profits since 2010.
A jump in volatility from July’s record low has given dealers more opportunity to make money and boosted an index of foreign-exchange returns by 2.1 percent this year. The price swings are being driven by a surge in the dollar, and with the U.S. currency forecast to strengthen throughout 2015, investors are optimistic the gains will continue.
“There are going to be major opportunities in the currency space,” Axel Merk, the president and founder of Palo Alto, California-based Merk Investments LLC, which manages about $400 million, said by phone on Nov. 24. “I was at a conference with a few institutional FX managers and everybody had this grin on their face. Finally, finally, volatility is back.”
It all looked very different mid-year, when unprecedented monetary easing from
central banks around the world had flattened the volatility that traders exploit for profit. Only now are returns picking up on speculation the Federal Reserve is preparing to raise interest rates for the first time since the financial crisis. Currency volatility also jumped on news that the Organization of Petroleum Exporting Countries resisted calls to cut output, which prompted a drop in oil prices.

Parker Index

Parker Global Strategies LLC’s index tracking 14 top currency funds is headed for its best annual performance since 2008. The measure, used by traders and investors to gauge returns across the foreign-exchange market, climbed to 129.89 on Nov. 21, its highest closing level since July 2013, and was at 129.64 today.
Back at the end of June, it was down more than 3 percent on the year and in August sank to its lowest level since 2006.
The positive returns are a relief for a market that has been roiled by a rate-setting scandal and the closure last year of FX Concepts LLC, once the world’s biggest currency hedge fund. More than 25 traders have been fired, suspended or put on leave since allegations emerged in 2013 that dealers colluded to rig the WM/Reuters rate, a benchmark for currency transactions.
The market still has some way to go before it matches the returns generated by stocks this year.

Shrinking Assets

The Standard & Poor’s 500 Index (SPX) of U.S. equities has climbed more than 12 percent in 2014, on pace for its third straight annual advance. Assets managed by funds focusing on foreign exchange shrank 6.4 percent in the first half to $18.4 billion, after a 20 percent drop in 2013, according to data compiled by Hedge Fund Research Inc. in Chicago.
Trading has starting to pick up since the middle of the year. CLS Group Holdings AG, operator of the world’s largest foreign-exchange settlement system, says it handled a record $5.94 trillion a day in September. The New York-based company settled more than 2 million payments on Sept. 17, the most since its creation 12 years ago.
“It’s been difficult as an asset class to attract funds where there’s been minimal volatility in FX while equity markets have been outperforming,” said Neil Staines, head of trading at ECU Group Plc, a London-based money manager specializing in foreign exchange. “Investors should be switching their attention back to FX, and that bodes well for the FX community.”

Dollar Rally

The Merk Absolute Return Currency Fund (MABFX) gained 1.5 percent in the past year, after losing 0.7 percent over five years, according to data compiled by Bloomberg.
Returns have risen along with the Bloomberg Dollar Spot Index, which tracks the U.S. currency against peers including the euro, yen and pound and this week touched its highest level since March 2009.
The dollar will strengthen versus all 16 most-traded currencies except Mexico’s peso, Norway’s krone and the South Korean won by the end of next year, according to strategist forecasts compiled by Bloomberg. The effects of the change in U.S. policy are amplified by the European Central Bank and Bank of Japan re-affirming their commitment to expanding stimulus.
The policy split is increasing price swings. JPMorgan Chase & Co.’s Global FX Volatility Index climbed to 8.92 percent on Nov. 20, the highest level since February and up from an all-time low of 5.28 percent on July 4.
Every one of Record Plc’s currency-investment strategies made money in the six months through Sept. 30 as volatility increased, according to James Wood-Collins, chief executive officer of the U.K.-based investor.
“It’s a reflection of an improved outlook for divergent monetary policy,” Wood-Collins, whose firm oversees about $50 billion, said in a Nov. 25 phone interview. “We’ve had a more supportive environment than for some years.”