Source: Zhitong Finance

The Federal Reserve is abandoning plans to cut interest rates, the Bank of Japan is supporting the yen. Bank of England officials disagree, and Sweden and the Swiss central bank have begun to relax monetary policy. The policy trends of central banks around the world are divided, and foreign exchange traders have already begun to “rub their hands.”

Fund managers at Allspring Global Investments and GAM Investments are switching to Group of Ten (G10) currencies and staying away from emerging markets, as many emerging market policymakers are already making every effort to cut interest rates. Ninety One's portfolio manager, Iain Cunningham, has accumulated 45% of net long positions in the US dollar, compared to only 5% at the beginning of this year.

Part of the reason why G-10 currencies are attractive is that people believe these currencies may fluctuate greatly, especially in the face of changes in global central bank policies and possible election surprises.

Furthermore, arbitrage trading is generating huge profits, which is largely driven by the strengthening of the US dollar. Bloomberg's index for tracking G10 currency arbitrage transactions has risen nearly 6% since January this year, and is expected to record the best half-year performance in 14 years.

G-10 currency arbitrage trading is expected to achieve the best half-year performance since 2010

“The G-10 has taken more action than in the past few years,” said Lauren Van Biljon, who is responsible for managing Allspring's $580 billion fund. “Divisions are everywhere. There are differences in economic growth, inflation, and trade expectations, which has led to surprises in the foreign exchange market.”

Overall market fluctuations are still relatively moderate, and the Group of Seven (G7) currency volatility index compiled by J.P. Morgan Chase fell to a two-year low in March. But some are already seeing early signs of transformation. The G7 Currency Volatility Index has been higher than the Emerging Markets Index this year, and this is the first time since 2017 that this has continued to be the case.

Major currency fluctuations bounce back from two-year lows

The exchange rate of the yen, the Swedish krona, and the Swiss franc against the US dollar has declined by more than 7% since this year. This decline was comparable to the Turkish lira, which fell 8%, one of the biggest declines in a basket of emerging market currencies.

Guglielmo Mazzola, head of investment expert at GAM Systematic Systems, said, “There is reason to expect the volatility of the foreign exchange market to increase because market expectations are different from the dynamics of the actual implementation of the central bank's interest rate policy.”

GAM's quantification-driven funds increased exposure to G10 currencies. Allspring funds increased their bets on the euro and the Swedish krona last month while cutting Indian rupees and Indonesian rupiah.

Capital flow data shows that capital is shifting from emerging markets to G10 currency transactions. According to State Street Global Investments Management, in April of this year, traders bought US dollars and New Zealand dollars and withdrew cash from Mexican pesos, Brazilian reais, and Indian rupees.

Arbitrage transactions have also increased the appeal of G-10 currencies. The index tracking arbitrage trading of G10 currencies has risen 5.8% since January, while the index tracking arbitrage trading in eight emerging market currencies has remained flat.

G10 currency arbitrage trading performance has caught up with emerging market currencies

Meera Chandan, co-head of foreign exchange strategy at J.P. Morgan Chase, said that G10 currency arbitrage trading will continue to perform well this year. She tends to borrow in Swiss francs, SEK, and Australian dollars, and lend dollars.

Of course, some fund managers say they are not exiting emerging markets and are opting for a wider range of transactions. CIBC Asset Management continues to bet on the Indian rupee while preparing for the weakening of the Swiss franc, Canadian dollar, and euro.

“The growing differentiation within developed markets means that our foreign exchange portfolio is getting wider,” said Michael Sager, head of multi-asset and foreign exchange management at CIBC. “We don't have to have to have a binary choice between developed or emerging markets. The more choices, the better.”

Meanwhile, Ninety One's Cunningham is watching the euro. He said that if the ECB cuts interest rates faster than the Federal Reserve, as traders currently expect, the euro is likely to fall to the same level as the US dollar.

Elections in regions such as the US, the UK, and the European Union may bring uncertainty to the market. According to TD Securities, there will definitely be more volatility in the future.

Mark McCormick, global head of foreign exchange and emerging markets strategy at TD Securities, said: “After mostly range-bound fluctuations, G10 currencies are once again becoming much more interesting.” “There's still quite a bit of room for change.”