Citizen Economists » forex

Trading on Japan

Ajay Shah — Mon, 14 Mar 2011 13:32:01 +0000

If you are in India, and hear news about the earthquake, tsunami and nuclear reactors in Japan, you might want to trade on this. Either because you are hedging Japan exposure that’s embedded in your Indian equity holdings, or because you think you are an informed speculator who has a better and faster judgment about what these events mean for Japan.

Sadly, the Indian capital controls don’t let you trade on the Nikkei 225, which is the Nifty of Japan. But there is something you can do: Trade on the JPY/INR futures trading on NSE.

Quite a few people seem to have thought like this. Here’s a graph of the turnover:

Now let’s pause to think about the story playing out on this market. On one hand, it’s the purely domestic speculators or hedgers, who are buying and selling from each other. This is fine, but where are the linkages to the global financial system?

The most important arbitrage which should be at work is in the currency triplet INR/USD, USD/JPY and JPY/INR. But unfortunately, currency futures trading in India does not include the USD/JPY contract, so one crucial leg of the arbitrage is not readily available. With turnover like $100 million in a day, I’m sure some people are doing such arbitrage in some painful ways.

Talk at R/Rmetrics Singapore Conference 2010 on Measurement of the Exchange Rate Regime

Ajay Shah — Mon, 15 Feb 2010 13:20:29 +0000

Anmol Sethy will do a talk on our work on testing, dating and monitoring exchange rate regimes at the R/Rmetrics Singapore Conference 2010, including some recent progress on parallel computation. For background, see this paper, which talks about the ideas, and the open source R package fxregime. This is now fairly mature work: many of the papers at the NIPFP DEA Program website have utilised the ideas and code. The 6th meeting of the NIPFP-DEA Research Program (9 and 10 March) is going to have interesting new work in this field.

Join the forum discussion on this post - (1) Posts

Interesting Readings for October 14, 2009

Ajay Shah — Wed, 14 Oct 2009 16:33:29 +0000

David Oakley reports on Brazil having made it to investment grade. This is their payoff to the immense progress that took place in the last decade in terms of fiscal, financial and monetary institution building. In many respects, India’s starting conditions today are similar to where Brazil was before these reforms.
Robert Shiller, in Financial Times defends financial innovation, and Robert Cryan, in New York Times worries that Canadian banks missed opportunities in this crisis.
Chiraga Chakrabarty, in DNA, on the need for INR/EUR futures. Once INR/USD and INR/EUR futures are trading, futures on USD/EUR will close the currency triplet and ensure efficient pricing of all three.
Raghuram Rajan in Financial Times on the neat idea of requiring banks to hold debt capital that will convert into equity when two triggers are met.
Read about Larry Summers and the US economic policy process in New Yorker magazine.
Anil Padmanabhan has an important column in Mint on the mess that is shaping up on the Goods and Services Tax.
James Lamont describes the world’s third largest producer of Gherkins: a firm named Global Green, out of Bangalore.
On TV, Vivek Law takes on the mess found in fund management products sold by Indian insurance companies.
Nell Minow in Financial Times with new thinking about corporate governance.
Ila Patnaik on RBI’s next moves. Also see The good news, analysed better and This is no time for a rate hike.
Vimal B in Financial Express on the internationalisation of the Chinese yuan.
Jayanth Varma is scathing about the SEC’s efforts at being motherly towards fat fingers.
India’s New Capital Restrictions: What Are They, Why Were They Created, and Have They Been Effective? by Bryan J. Balin of The Johns Hopkins University School of Advanced International Studies (SAIS).
Alan Blinder thinks that we should all be long India.
Shubhashis Gangopadhyay pleads for the removal of capital controls against venture capital and private equity.
Counterfactual history, by Ramachandra Guha: Episode 1: What if Subhas Chandra Bose had returned home sometime after WW-II ended?.
How Sam Yin Chueh changed the world.
We have serious problems with freedom of press in India.

Join the forum discussion on this post - (1) Posts

Interpreting Recent Movements of the Rupee-Dollar Rate

Ajay Shah — Mon, 12 Oct 2009 18:20:13 +0000

In recent weeks, there has been a lot of focus on the appreciation of the rupee against the dollar. In an opinion piece in Financial Express today, I point out that the US dollar has fluctuated considerably in the period after September 2008, and interpret the recent events on the Indian currency market. At first, in the `flight to safety’ into US government bonds that came about after the Lehman shock, the US dollar gained ground. As the global financial system has gained confidence, the reversal of this `flight to safety’ has meant a concomitant decline in the US dollar.

These ups and downs of the US dollar have important implications for our intuition in India about the rupee-dollar rate. If we think the US dollar is roughly fixed, then the pursuit of an inflexible rupee-dollar rate can be interpreted as some kind of `stability’. But if the US dollar itself is a fluctuating yardstick, it is hard to justify efforts at RBI to obtain inflexibility of the rupee-dollar rate. When the dollar declines in value, an attempt at holding on to a rigid rupee-dollar rate is tantamount to forcing a rupee depreciation, and vice versa.

Greater flexibility in the rupee dollar rate will free up monetary policy to pursue the more important goal of stabilising the domestic business cycle. But along the way, for firms to learn to live with greater flexibility of the rupee dollar rate, well functioning currency derivatives markets are required. RBI needs to first step away from the present strategy of banning most of these markets, so as to be able to move forward to greater flexibility of the rupee.

On the macroeconomic arguments about the long-term decline of the US dollar, see Wolfgang Munchau in the Financial Times today.

Risk On? The RBA bites the Bullet

Claus Vistesen — Wed, 07 Oct 2009 14:00:09 +0000

I am not an ardent watcher of the Australian economy so I shall leave it neatly to the side of whether this was expected or, Bloomberg so famously puts it, unexpected.

Australia’s central bank unexpectedly raised its benchmark interest rate from a 49-year low and signaled further increases in coming months amid signs the economy is strengthening. Reserve Bank Governor Glenn Stevens increased the overnight cash rate target to 3.25 percent from 3 percent in Sydney today. Only one of 20 economists surveyed by Bloomberg News forecast today’s move. The rest predicted no change.

The local currency jumped as Australia became the first Group of 20 nation to raise borrowing costs since the start of the global financial crisis more than a year ago. Rising job vacancies, retail sales and house prices, plus surging business and consumer confidence support Stevens’ view that the “basis for such a low interest rate setting has now passed.”

Carry traders will of course feel that warm fuzzy feeling in the stomach by now with the prospect of Australia (and perhaps New Zealand or others) raising rates while the Fed continues to supply the system with free liquidity. The only question is of course whether risk is really on here or whether we are about to get hit by another anvil exactly brought about by a retrenchment of stimulus. I don’t know, but this is also beyond the point here. The only question which needs to be answered at this point in time is, how high will it go?

To parity and beyond? (graph courtesey of Reuters, click for better viewing)

Currency Futures Liquidity Ahead of the Forward Market?

Ajay Shah — Wed, 23 Sep 2009 11:53:42 +0000

At NSE, currency futures did $1.8 billion yesterday. With this, India is starting to look like the first country where the turnover of the currency futures market is big when compared with the currency forward market.

Turnover is, of course, not liquidity. Liquidity is about the transactions cost faced when transacting. Liquidity comparisons between the OTC market and the futures need to take into account the fact that the OTC market trades bigger contracts. So, let’s see what impact cost is visible in the information present on the web, pertaining to closing time (5 PM) on the 22nd. The quantities available at the best five prices are visible on the web. There is surely more available beyond, but you probably don’t want to trade at those adverse prices.

Let’s focus on 1000 contracts, or $1 million. Based on conversations, I get the sense that the forward market would have impact cost of 0.01% to 0.02% for this transaction size. The graph shows that the NSE contract has smaller numbers than this for both buying and selling.

(Click on the graph to see it more clearly). The futures market seems to be able to serve upto $6 million to a buyer and $2 million to a seller, while suffering reasonable values of impact cost, within the top five prices.

This is admittedly one data point. Late in the day, I noticed a big number for turnover and wondered what was happening to liquidity, so I looked at the `market by price’ display visible on the web. But for a currency futures market to beat a currency forward market on liquidity is unusual, even if it is for one data point.

Gold isn’t in Backwardation, the USD is in Contango

Bron Suchecki — Thu, 30 Apr 2009 18:45:51 +0000

A lot of confusion on gold going into backwardation. I wrote about this in October in this blog where a commentator got confused. Recent articles by Professor Fekete have spawned more confused comments, see Brad Zigler’s article for an example (and also my comments to it).

People get all confused about it because they aren’t thinking of gold as money. What was the Yen carry trade? Borrow JPY at bugger all, do an FX to sell JPY-buy USD and invest the USD at a higher rate and pocket the difference in interest rates but have exposure to the FX rate. Interest rate differentials exists for all currencies and they are not arbitraged away because there is risk to the change in the FX rate, the FX rate being the “price” of that currency in terms of another. An alternative way I look at it is that differences in interest rates exists because of the markets assessment of the risk of one currency inflating or deflating relative to the other, wiping out the profit from the interest rate differential.

Lets assume USD rates of 2%, AUD rates of 4% and an exchange rate of 0.65.

1. You borrow USD 650 at 2%, which means you have to pay back USD 663 in 1 year.
2. You sell USD 650 / buy AUD 1000 at 0.65 now.
3. You lend AUD 1000 at 4%, which results in AUD 1040 in 1 year.
4. If the FX rate doesn’t change, you then sell AUD 1040 one year later for USD 676.
5. Repay USD 663, leaving profit of USD 13.

If you ask a bank for a 1 year forward AUD/USD FX rate, they do steps 1 to 3 and then calculate

4. In one year’s time you will have AUD 1040 but owe USD 663, so the FX rate that this equates to is 0.6375.

Now there is nothing stopping you from borrowing AUD at 4% and selling it for USD to invest at 2%, but as you are negative cash flow you really need a big move in the FX rate to come out ahead. This means that the lower interest rate currency tends to have more borrow and sell pressure on it because the higher interest rates of the other currency mean you have a bit of a “buffer” if the FX rate moves against you.

Anyway, just think of gold as a currency (ie money) and the lease rate as the interest rate on gold(money). Therefore, one can borrow gold at lease rate, sell it and invest cash at LIBOR. Therefore the difference in these two interest rates is your profit, assuming no change in the gold/USD FX rate (ie the USD gold price).

For 1 Dec 08 for 1 month at LBMA:

Lease Rate = Gold Interest Rate = 1.69875
LIBOR = USD Interest Rate = 1.91125
GOFO = 0.21250

All this tells me is that there is a slight advantage to borrow and sell gold for USD, but the small advantage does not seem to outweigh the risk of the gold/USD price moving against you (ie up). If gold interest rates go higher than USD rate then what? Well to me this “backwardation” as it is called, just means that there is a slight advantage to borrow and sell USD for gold, as long as you don’t expect the gold price to drop.

Probably worth noting here that as at 1 Dec you could have borrowed gold at 1.7% and sold it for AUD, investing the AUD cash at 4.25%. So this means that while USD gold may be toying with backwardation, AUD gold is firmly in contango.

Now interest rates for currencies change all the time and go above and below each other all the time. When that happens it is noteworthy but not exclaimed as extraordinary. Why is it different for gold? Well in my AUD/USD example we are talking about fiat currencies.

In the USD vs gold situation, however, we are not talking about “equal” currencies – one cannot be created, the other can. Think about it, in regards to my earlier comment that “differences in interest rates exists because of the markets assessment of the risk of one currency inflating or deflating relative to the other.”

We are so used to talking of 1oz = xxx dollars when it should really be $1 = xxx ounces. Then you see that gold hasn’t went into backwardation, but that USD has went into contango. Ouch, my brain hurts, but that is to be expected as we move into a world where you price things in ounces, not dollars.