Fixed Income is Dead, Long Live FX

In 2019, fixed income was king. Many macro funds turned to rates RV and duration trading, and many went as far as shutting down currency risk taking. This trend was also prevalent within pension funds. They focused on equity and credit beta, and the hedging benefit offered by duration, while ignoring FX opportunities.

But then came COVID19, which has pushed all major fixed income markets toward zero. In g10, the highest 2y rate is 0.29 pct (in New Zealand), and the average 10y rate is at just 0.20% (dragged down by negative rates in Europe). Meanwhile, volatility has collapsed: Yield volatility in the US, as captured by MOVE, made new historic lows last week.

Global central banks continue to play an outsized role after having successfully suppressed the risk parity unwinds that predominated in late March. Looking ahead, fixed income volatility is unlikely to come back quickly, unless global inflation sees a dramatic regime shift. In fact, any temporary fixed income volatility is likely to be met by ‘Yield Curve Control’ policies, as already adopted in Japan and Australia.

At the same time, global FX markets have come back to life. EURUSD has moved almost 10pct since the European Recovery Fund was announced on May 18, and we have seen a significant USD weakening trend more broadly, especially in g10 (with CVIX 75% of the pre-COVID lows, and interbank volumes are up significantly).

For institutional investors, capturing some of these FX moves will be crucial to performance. There is little to no carry left in traditional sovereign bond markets, and the potential for duration rallies is also dramatically diminished. On a relative basis, FX now offers much more potential for alpha generation, although no strategy is without risk.

This year has been a special one for the team at Exante Data, and our early focus on COVID19 has been important to the quality of the analysis and advice we have provided. But we never stopped focusing on FX, and we are happy to observe that investors are coming back to the asset class, and expressing renewed strong interest in our FX expertise.

This trend will continue. Institutional investors will have to adopt and be willing to take more risk, and generate returns in global FX; for some, perhaps even via new exposure to Chinese bonds. Taking currency risk effectively, may even be a matter of survival. Long live the new king, FX.

Jens Nordvig
Founder and CEO
Exante Data Inc.

Links to some previous public letters:

On the Rise of Alt-Data (July 7, 2020)

FT-op-ed: Did anyone notice that the Macron-Merkel plan is a very big deal (May 21, 2020)

How long must we do this: On optimal Social Distancing (April 16, 2020)

COVID: In a time of macro crisis, we would like to thank our clients (March 5, 2020)

 

 

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