(Bloomberg) -- The unprecedented level of calm pervading global currencies is pushing investors to rethink their approach to the $6.6 trillion-a-day market.
Morgan Stanley (NYSE:MS) Investment Management has pared its foreign-exchange exposure, awaiting a clearer theme. Amid the trend-less torpor, Russell Investments Ltd. is focusing on value, and is forsaking major currencies in favor of those from developing economies. For State Street (NYSE:STT) Global, that same approach leads to Scandinavia as the firm scours the Group-of-10 for opportunities.
Turbulence picked up a hair this month in the run-up to the Dec. 15 deadline for additional U.S. tariffs on China, as investors braced for the possibility of rocky times ahead. Events in the next few days could also jump-start market swings: The Federal Reserve and the European Central Bank will deliver policy decisions, and the U.K. holds a general election that could pave the way for Brexit. But for the time being, volatility remains near all-time lows across some major currency pairs.
That’s a boon for companies, which can hedge international revenue more cheaply than ever, if they so choose. But it’s a problem for traders who rely on swings and trends to squeeze out a profit from FX. While the S&P 500 is on pace to log its best annual performance since 2013, and Treasuries are headed for their biggest gain since 2011, currency-focused funds are suffering a fourth straight year of losses.
“It’s difficult to make money in these low-vol environments,” said Aaron Hurd, senior portfolio manager in the currency group at State Street (NYSE:STT) Global. “Nothing’s firing on all cylinders, and that just breeds confusion and lack of conviction.”
Currency turbulence has been declining in part because market expectations for central banks and the relative strength of major economies have largely been met. A JPMorgan Chase (NYSE:JPM) & Co. measure of global FX volatility is close to a five-year low, while one-month implied volatility sank to all-time lows in the euro, Canadian dollar and New Zealand dollar late last month.
Low Conviction
Morgan Stanley (NYSE:MS) Investment Management has decided to bide its time. The fund manager has reduced its currency exposure to 1% to 2%, from typical levels of 5% to 7%, according to portfolio manager Jim Caron. It’s difficult to create a compelling trading narrative with most major currencies locked in such tight ranges, he said.
“We’re not going to take just a punt on the currency,” he said. “It’s hard for me to have high conviction and want to expose myself very greatly to something I believe is going to just kind of drift, as opposed to trend.”
He anticipates that the catalyst to increase currency exposure back to normal levels would be if the U.S. and China were to agree to a phase-one trade deal. Chinese officials expect the U.S.’s planned Dec. 15 tariff increase to be postponed, giving more time to negotiate an interim pact, according to people familiar with the matter.
Emerging Focus
The currency exposure that MSIM still has on is mostly weighted to Latin American, South American and some Asian currencies, Caron said. That’s based on the view that growth in those emerging economies will draw capital. Most emerging-market currencies have weakened versus the dollar in 2019.
“EM can perform reasonably well next year, and we think that it’s going to to attract investment there,” Caron said. “That’s going to come at the expense of the dollar.”
The quest for value is a common theme among many investors facing an FX landscape devoid of lasting moves.
Russell, which manages about $5 billion in active currency -- meaning FX as an asset class -- has seen returns of about 5% since May in its emerging-market value strategy. There’s potential for more gains there, according to fixed-income and currency research head Van Luu.
Scandinavia Calls
For Amundi Asset Management’s Andreas Koenig, the volatility malaise makes value the dominant strategy in foreign exchange at the moment.
He’s optimistic about the Norwegian and Swedish currencies in 2020 should the global economic outlook rebound from the headwinds of the trade war. The two currencies have both slumped more than 5% against the dollar in 2019, making them the worst-performing G-10 currencies. For Norway’s krone, the tumble has come even as the Norges Bank hiked rates.
Barring a marked global slowdown, “currencies which were affected by these negative expectations of trade and growth and are undervalued should come back into interest,” said Koenig. He’s head of global currencies at Amundi, which oversees $1.7 trillion.
State Street (NYSE:STT) Global’s Hurd is also looking to Scandinavia. He said the krone is one of his largest bullish positions.
Hedging Opportunity
For Brad Bechtel at Jefferies, staying long the dollar has been a profitable way to navigate the tranquility in FX, given the appeal of still-positive U.S. yields.
And because American short-term rates are higher than in most other developed markets, dollar-based investors can benefit by entering short positions against low-yielding currencies, he said.
However, he sees a risk that volatility may be poised to rebound amid trade negotiations, Brexit developments and discussions of fiscal stimulus in Germany. For him, buying three-month euro-yen volatility is the best way to position for that.
“Over a three-month kind of time horizon, we would anticipate that at least a couple of opportunities are going to arise,” he said. “Euro-yen vol is super cheap, so it’s not a bad way to hedge your exposure for the remainder of the quarter.”
(Adds reference to events this week.)
