Treacherous Forex Movements Makes Proxy Trades Difficult

The unusually volatile and highly unpredictable behaviour of currencies in recent times has led to a lot of confusion among investors and, according to the Financial Times article of September 20, one big loser from this has been ‘proxy trade,’a phenomenon which emerged after the global financial crisis in 2008. “Proxy trade” describes the practice of investors expressing a view on equities by buying a currency pair. Some currencies are considered to be strongly correlated to global equities and with buying currencies cheaper and more liquid than buying shares, this has viewed as an effective alternative play on these kinds of equities.

With all asset classes highly correlated in recent years, “risk-on, risk off” trading patterns (roro trade) have become a dominant force on the markets for long periods of time. Certain aspects of ‘roro’ trade has been exploited by equity traders, helping them realise attractive profits by correctly predicting market swings. Some currencies, highly correlated with the US stock market, presented traders with the opportunity to form a hedging strategy, using forex options. An example of this would be the practice of selling the Australian dollar against the yen. The correlation of the Aussie with global equities and the specific nature of the Japanese currency which usually behaves as haven (meaning that it falls when risk appetite rises) have made this particular strategy very popular amongst equity traders.

But the Aussie and other traditional proxy currencies such as the yen and the Swedish krona have been difficult to predict lately, putting proxy traders in a difficult situation.
Normally, these currencies respond to the changes of global risk appetite by either rising or falling. However, lately, proxy currencies have been more influenced by central banks’ intervention and demand from bond investors for higher yielding havens. According to Stephen Jen, founder of the SLJ Macro Partners hedge fund, *“proxy trades are less accessible than in the past”.*

The Japanese yen, for example, should have depreciated on the back of the announced Fed easing, with risk appetite rising, but instead it strengthened its positions. Meanwhile, an increasing number of investors have started treating the Australian dollar and the Swedish krona as havens, because of their high yielding government bonds. As a result of this, the AUD/YEN pair is no longer so highly correlated to the S&P 500 (although the correlation levels are still a lot higher compared to those before the financial crisis).

Proxy trades have been less successful for currency traders as well. Richard Usher, head of forex spot trading at JPMorgan (NYSE:JPM) in London revealed that an attempt on the S&P via forex that the financial firm made last year, failed because of *“all the central bank money in the market.”*
However, many traders aren’t ready to give up on proxy trades yet. According to JPMorgan’s currency desk a popular trend in September has been to sell the Aussie on profit, capitalising on dropping iron ore prices and the slowdown in China. Stacy Williams, a quant strategist at HSBC in London, revealed that, after a quiet period in the summer, the bank’s roro index has reached “insane” levels.
Claims of roro trades coming to an end might be premature, but the current situation on the financial markets will most certainly raise more caution amongst investors, exercising the practice.