Hedge Demand Soars as Funds Seek to Tame Volatility
Comment of the Day

August 30 2013

Commentary by Eoin Treacy

Hedge Demand Soars as Funds Seek to Tame Volatility

This article by Cecile Gutscher for Bloomberg may be of interest to subscribers. Here is a section
The prospect of the Fed reducing its bond purchases and rising tensions in the Middle East are also boosting the haven appeal of U.S. assets, including the dollar.

America's currency has gained 1.5 percent in the past three weeks, the biggest advance in more than a month, according to the Bloomberg U.S. Dollar Index, which tracks the greenback against 10 major peers. The gauge reached 1,034.23 today, the highest level since Aug. 2.

The dollar is the second best-performer this year among 10 major currencies tracked by Bloomberg Correlation-Weighted Indexes. The U.S. currency strengthened 5.7 percent against the basket of peers including the British pound and Japanese yen, compared with the 17-nation euro's 6.1 percent increase.

“The dollar should be going into a period of some volatility and probably bigger volatility than we've seen in the last four to six weeks,” Jens Nordvig, the managing director of currency research at Nomura Holdings Inc., said by phone from New York yesterday. “The key events are Fed-related” and “whether we're going to get the tapering or not in September.”

Eoin Treacy's view Demand for currency hedged investments surged from early this year as investors sought a way of profiting from the devaluation of the Yen. The WisdomTree Japan Equity Hedged Portfolio (DXJ) currently has a market cap of $10 billion which would have been closer to $13 billion at its peak earlier this year. This is one of the most popular but certainly not the only fund offering hedged exposure to Japan.

Japan's efforts to devalue its currency have played an important role in the subsequent weakness of other Asian currencies. The focus of attention when the Bank of Japan embarked on QE was on the reaction of the G7. However, while Japan, Germany and the USA target different markets, Japan and a number of its neighbours target the same demographic. ASEAN countries in particular could not stand idly by and allow their economies to become less competitive versus Japan.

This table of the total return on global currency markets highlights not only the weakness of the Yen but how much other Asian currencies have fallen in sympathy. The pace with which foreign investors have withdrawn capital from economies with weak currencies has spurred administrations to act. Indonesia raised rates yesterday and other countries can be expected to follow this example.

Over the last decade investors in Asia have become accustomed to concurrent currency and capital market appreciation. The advent of Japan's devaluation has changed the region's dynamic which increases not only demand for currency hedged instruments. This is unlikely to change anytime soon.

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