Exotic Currencies to feed the market

andres del risco

The Greek elections were never going to present the world with a solution to the Eurozone crisis and at the time of writing they haven’t even given us a day’s worth of gains in markets; the half-life of good news is getting increasingly shorter in the Eurozone and soon the boys at CERN will be the only people who can accurately measure it.

The outcome the market had been dreading failed to materialise and the result is a basic re-run of the past election and this therefore means that, although it may be too early to tell, the need for centralised policy intervention from the world’s central banks can wait a while.

The market has been calling on central banks to increase liquidity further in recent months however, they have been reticent to do so as yet. The ECB gave no hint of further LTRO cash while the Bank of England have decided on a more focused scheme for businesses as opposed to the typical bond buying program it has been part of in recent years. The focus has now shifted to the Federal Reserve and their meeting on Wednesday night.

The split in views of analysts is fairly wide for this meeting with some going for no more easing at all from the US authorities while some are looking for a massive injection. The reasons are simple and well-known; financial headwinds from the crisis in Europe combined with dwindling confidence and a sense of “what’s next” has hammered the incentive to spend. This summer has drawn massive parallels with the same period last year. A promising start faded as concerns over Greece saw risk run for the hills, growth suffered and the banks eventually threw more cash at the problem.

The Fed have been cagey in communications, both verbal and written, about the prospect of another round of economic stimulus leading some to believe that they are trying to wean the market off the artificial high that these open-market operations provide.

Unfortunately, and especially in an election year, the pressure to act may overcome their desire to restrain the market. US growth was surging ahead at the beginning of the year but has since tailed off rapidly emphasising our fears that while this will be the second recession for the western world, the Far East will now be invited to the same depressing party. The economy is the battle ground for every election out there at the moment and the US presidential is unlikely to be any different.

Indeed the focus of things will shift from Europe to the US come the end of the year as the elections and the “fiscal cliff”; the cessation of various tax cuts and the imposition of spending cutbacks will throw politicians back into the limelight. Central banks may have to help markets just one more time while the world’s political elite continue to fiddle while Rome, Madrid, Athens and, possibly, Washington burns.

Trade of the Week

This week’s trade of the week is a ‘Double Leveraged Seagull”. This differs from the usual risk reversal in that, for an increased risk, the client’s strike improved by 2.5 cents. The client decided to hedge the next 12 months of exposure with this trade to lock in some of the gain in GBPUSD we have seen recently.

The client’s strike was set at 1.5450 on his option which allows the client to benefit all the way up to a rate of 1.6250. If on expiry the rate is above your cap level then you must buy 2x the amount at that cap. He is of course able to trade at spot between 1.5450 and 1.625. The added risk is should GBPUSD fall below 1.4800 then for every percentage point below 1.4800 then he loses the same off the strike of 1.5450. If the rate is not below 1.4800 then he is completely protected at 1.5450.

This strategy is premium free and allows a hedge with a strike only slightly below forward while a normal risk reversal would see a WCR at least another 2.5 cents worse. As there is a potential further strengthening for sterling in the future the structure allows for a large amount of beneficial movement.

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Exotic Currencies to feed the market

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