FX hedges get expensive as central banks tighten

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INVESTORS looking for safeguards against emerging risks in the placid foreign exchange (FX) market may want to act now — before global central banks start to make waves later this year.

That’s the message from both Standish and Wells Fargo, who view the prospect of tighter global monetary policy as a potential trigger for increased turbulence. The rocky times may arrive sooner than current volatility levels suggest, with the European Central Bank fine-tuning its exit from quantitative easing and the Federal Reserve continuing to hike interest rates.

Still-low volatility presents an opportunity to guard against the coming turmoil, according to Brendan Murphy, head of Global and Multi-Sector Fixed Income for Standish, a part of BNY Mellon Asset Management North America Corp., which oversees $576 billion.

“We’re definitely looking for ways we can protect the portfolio if volatility picks up, because it’s relatively inexpensive to do that right now,” said Murphy. “Realized volatility is low, implied volatility is low — we think that probably doesn’t persist forever.”

Six-month dollar-yen implied volatility offers an attractive safeguard, according to Murphy, given the yen’s sensitivity to US  interest rates and the Japanese currency’s flight-to-quality characteristics. Despite inching higher to start 2018, implied volatility on the pair remains roughly 25% below where it was a year ago.

Volatility languished in the wake of the global financial crisis as the world’s central banks pursued loose monetary policies to spark growth. That dynamic may reverse soon, with global monetary policy likely to become less accommodating over the course of 2018, according to Wells Fargo.

“Currency volatility has been subdued overall, which may in part reflect still-benign global monetary policy settings,” wrote analysts including Nick Bennenbroek in a note dated Feb. 5. “Accordingly, corporates and investors considering options-based hedging structures may want to contemplate transacting while currency volatility remains relatively low.” — Bloomberg