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The Resource for the Global Finance Profession

Trading After the End of the World

  • By Karl Schamotta
  • Published: 2013-01-11

Last year marked the conclusion of a b'ak'tun—a 144,000-day time-cycle under the Mayan Long Count calendar, which many interpreted to mean that world would end.

Clearly, if you are reading this, the Earth remains intact. Instead, archaeologists now believe that the Mayans were talking about a change in the foreign exchange markets.

After living in a world of dramatically divergent growth patterns for almost a decade, currency traders woke up to an entirely different reality in the latter half of 2012.

The conditions for this shift were laid in 2011, when many of the largest asset managers began to abandon their dollar-funded emerging market positions in favor of a more nuanced approach to global allocation. Growth decelerated as credit conditions tightened in a number of countries that had long been the darlings of the global investment community, and many benchmarks underperformed their developed counterparts.

Growth rates began to converge, completely upsetting the assumptions that had long governed international capital flows.

In the latter half of 2012, this had a substantial impact on the size and composition of the currency markets.

Speculators unwound their highly leveraged international arbitrage bets, and the carry trade collapsed. Confounding their many critics, the dollar and euro snapped back.

Trading volumes plunged, while wide swings in exchange rates gave way to frenetic volatility within much tighter ranges.

The world ended, and a new world began.

As we go to pixels, currencies remain highly volatile, and secular trends are only fleetingly visible. The clear demarcations that once dominated the markets have dissipated, leaving confusion and disarray in their wake. Currency speculators and hedge funds are struggling to generate profits in this environment.

For treasurers however, there are silver linings sewn into the dark clouds.

In many senses, these are ideal conditions for a sophisticated treasury department. Where strong trends can exert an almost unstoppable force on a corporate balance sheet, range-bound markets can generate incredibly persuasive pricing opportunities. While long-term currency risks should still be hedged away using instruments like forwards and swaps, short-term volatility can be harnessed to incrementally improve entry and exit points.

The investment environment is also improving. As expectations converge on a worldwide basis, valuations are moving much closer to fundamentally appropriate level, and many trading relationships are beginning to rebalance.

Huge growth disparities are losing their destabilizing influence on international capital flows, and this is laying the foundation for a more robust global economy. For all the talk of currency wars, this new reality is relatively peaceful.

Why is it so important to see these developments in a positive light? Because financial professionals are conditioned to relentlessly protect the bottom line against risk. But it's important to remember that failing to harness opportunity is the greatest risk of all.

Despite the general pessimism, many opportunities will be created in this new world - make sure that you are prepared to capitalize on them. Happy trading, and happy New Year!

Karl Schamotta is president of AFP of Canada-Calgary and a member of the Risk Editorial Advisory Board.

This article appeared in the latest edition of Risk.

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All rights reserved.

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