Super Fund in Australia

Australian superannuation funds that failed to hedge their forex exposure took a hit when the Australian dollar fell against its US counterpart in 2011. Is there a solution in the cross-currency basis swap market?

As Australia increases its ownership of offshore assets across global equities, real estate, infrastructure and other alternative asset classes, foreign exchange has become a major contributor to the investment returns of Australian pension funds.

According to the 2011 Superannuation FX Survey by National Australia Bank (NAB), which polled 49 of the country’s largest super funds with combined AUM of A$523 billion (US$560 billion) representing 79% of the market, unhedged portfolios lost 12.7% in 2010 on adverse currency moves alone, while 100% hedged positions gained 4.5%.

Since mid-2009 the effect is more pronounced, with unhedged positions giving up 30% against gains of 8% for fully hedged positions. The 38% differential represents an opportunity cost to overall portfolio performance of some 3.25% per annum since then, according to NAB.

Against a backdrop of increasing offshore exposure and a focus on relative performance versus their domestic peer group, it should follow that Australian super funds have significant interest in optimising their currency overlay strategies. Outside of the fixed interest sector, however, investment managers say there is little consensus around forex risk management best practice with some funds ignoring it altogether.

Troy Rieck, managing director with the Brisbane-based Queensland Investment Corporation (QIC), an institutional investment manager with AUM of A$60 billion, reports a disparate range of operational approaches. “Some funds use their asset managers to run forex hedging strategies, some rely on their custodians, while others choose not to hedge or don’t really think about it at all,” he says.

Furthermore, the tendency of incumbent providers to rely on traditional hedging tools can act as a drain on liquidity with painful consequences. Between July and October 2008, the Australian dollar dropped by more than 30% versus the US dollar, leaving funds long the Aussie dollar after one-month and three-month AUD/USD forex forward hedges faced a severe, one-off liquidity event. As the deeply out-of-the-money contracts expired, funds faced payouts that far exceeded their strategic cash holdings. Assuming a 30% decline in the AUD versus the US dollar, and net unhedged forex exposure of 17%, the average fund was forced to pay as much as 5.1% (30% x 17%) of its total fund value.

With this experience still fresh in their minds, investment managers are getting excited about a forex overlay approach that has been a favoured tool of international bond issuers and fixed income portfolio managers for some time. The strategy employs longer-dated cross-currency basis swap contracts – plain vanilla derivatives contracts quoted on multiple screens, which advocates argue allow funds to better manage liquidity requirements by smoothing out income gains and losses. Moreover, they argue, it is accretive to the overall risk-adjusted portfolio returns.

“The rollover risk arising from FX overlay programmes based on short-dated contracts can be very large, as the past few years have shown. By using longer-dated cross-currency basis swap contracts, funds can improve the liquidity profile of their FX overlay, and get paid for a risk management activity which they have to do anyway,” says QIC’s Reick.

Funding requirements

The opportunity for better risk-adjusted forex overlay performances is driven by market expectations around the offshore funding requirements of Australian financial institutions. Essentially, the more offshore debt issuance announced by Australian banks, the greater the cost of converting that funding back to the domestic currency using cross-currency basis swaps and vice versa.

At the same time, the relative issuance activities of international borrowers in the kangaroo (domestic Australian) market can have an offsetting effect, with increased issuance and related supply of the domestic currency acting as a cap on basis swap spreads. Since the global financial crisis, broad capital market liquidity and the general availability of funding has amplified the supply/demand dynamic, with the AUD/USD bases turning deeply negative during the Lehman crisis in late 2008 and widening substantially in 2010 on the back of heavy offshore issuance.

Australian banks have recently increased US dollar and euro covered bond issuance as demand for senior bank paper dried up. Issuance of US dollar-denominated asset-backed securities by Australian banks, for example, grew to more than US$1.8 billion in 2011, up from around US$750 million in 2010, while US dollar covered bond issuance grew to US$2.2 billion in 2011 from zero in 2010. Growth of euro covered bond issuance is even more pronounced, with US$17.6 billion-equivalent printed across 18 deals in the first quarter of 2012 alone, according to data provided by Dealogic.

Although the AUD/USD cross-currency basis has tightened in from the 2010 levels across its term structure, increased offshore issuance has kept the basis at elevated levels so far this year.

AUD

The G20 meeting in Mexico did little to quell global markets overnight as very little was achieved leading the slide of risk assets through the early part of trade.  The Finance ministers failed to agree on any increase to the IMF contribution to the Euro zone debt fund.   Although Germany did bear some of the blame for the lack of agreement they did manage to convincingly pass the second EU/IMF bailout of Greece by 496 to 90 votes.  This however did not spur confidence with European stocks dragged down, and demand for the US dollar increased with the Australian dollar trading back to 1.065 and the Euro slipping down to 1.3366 at the start of the US session. 
 
With confidence low a surprise print on pending how sales turned the US session on its head.  The S&P was down over 100 points at the start of the US session, but rebounded as monthly pending homes sales came in at 2% nearly double what was expected.   The S&P finished up 0.14%, and as a result the US dollar was sold off with the Australian dollar following equities as it peaked at 1.07820 USD a few hours ago.   There weren’t any other key economic news out overnight which extenuated the bounce from the G20 through to the pending home sales. 

After a solid run for the month of February the Yen depreciation march halted overnight as it retreated from it 8 month highs.  The price of oil is getting the blame for this demand for the Yen as WTI futures price of 107.81 worrying the ability for the US economic recovery and seeing bullish bets on its recovery possibly being unwound.   We do have Japanese retail sales data out from January this morning with a 0.2% contraction expected. 

Today’s local session does not have any economic data of note and the US equity session saw profit taking occur as it wound up which has given the local session little to open on.  The Australian dollar is 25 pips off its the high following the late paring of gains and we don’t expect too much volatility unless Japanese retail sales data is well away from median estimations.  At the time of writing the Australian dollar is buying 1.0749 USD.

AUD

Forexpros - The Australian dollar ended the week lower against its U.S. counterpart on Friday, as markets were jittery amid ongoing concerns over Greece’s debt woes despite signs of progress in the euro zone.

AUD/USD hit 1.0596 on Thursday, the pair’s lowest since February 1; the pair subsequently consolidated at 1.0693 by close of trade on Friday, shedding 0.71% over the week.

The pair is likely to find support at 1.0591, the low of January 27 and resistance at 1.0773, the high of February 16.

Sentiment slightly improved earlier in the week after euro zone finance ministers agreed to deliver a EUR130 billion bailout package to Greece. 
However, Eurogroup Chairman Jean-Claude Juncker said on Friday that he could not rule out that Athens may need a third bailout.

Meanwhile, Reserve Bank of Australia Governor Glenn Stevens said Australia’s benchmark interest rate is “about right for the moment” as economic growth is close to trend while concerns over the effects of the euro zone’s debt crisis on global output eased.

The Aussie remained supported after Greece launched a bond-swap offer to private-sector creditors, formally inviting them to exchange their holdings of government debt for new securities. 

Meanwhile, markets were eyeing the European Central Bank, scheduled to launch a second liquidity operation next week, offering unlimited three-year loans to European lenders, after the bank carried out a similar successful operation in December.

In the U.S., a string of improved economic data lifted sentiment. A report by the University of Michigan on Friday showed that its index consumer sentiment rose to 75.3 this month from 75 in January.

On Thursday, the U.S. Department of Labor said that the number of individuals filing for initial jobless benefits in the week ending February 18 held steady at 351,000, the fewest since March 2008.

Earlier in the week, the Reserve Bank of Australia said in the minutes of its February meeting that it remained willing to ease policy if commodity and raw material demand were to “weaken materially” although it left rates unchanged this month. 

Meanwhile, official data showed that Australian wage prices rose more-than-expected in the fourth quarter, adding 1% after a 0.7% increase the previous quarter. Analysts had expected wage prices to rise 0.8% in the fourth quarter. 

In a separate report, the Melbourne Institute said that its inflation gauge for Australia rose 0.5% in January after a 0.1% fall the previous month.

The data came after a report by the Conference Board showing that its leading index for Australia rose 0.2% in December after a 0.3% decline the previous month.

In the coming week, markets will be watching developments in the euro zone, with investors eyeing the uptake on Wednesday’s refinancing operation by the ECB, as well as the outcome of votes in Finland and Germany on Greece’s bailout.

Investors will also be focusing on Wednesday’s U.S. data on fourth quarter economic growth, in order to gauge the strength of the country’s economic recovery.

Ahead of the coming week, Forexpros has compiled a list of these and other significant events likely to affect the markets. The guide skips Friday as there are no relevant events on this day.

USDAUD

The Dow Jones-FXCM U.S. Dollar Index remains 0.34 percent lower from the open after moving 109 percent of its average true range, and the greenback should continue to track higher over the next 24-hours of trading as the 30-minute relative strength index bounces back from oversold territory. Looking at the broader channel, the dollar looks poised for another move towards 9,900, and we maintain a bullish outlook for the reserve currency as the fundamental outlook for the world’s largest economy continues to improve. However, as risk trends continues to dictate price action across the financial market, the rise in market sentiment may keep the USD within a narrow range, and we may see the dollar consolidate further before making a larger move to the upside.

As the more robust recovery in the world’s largest economy curbs speculation for another large-scale asset purchase program, the bullish sentiment underlining the USD should continue to gather pace over the near-term as Fed officials soften their dovish tone for monetary policy. Indeed, central bank hawk Richard Fisher talked down speculation for more easing, arguing that the FOMC’s most recent policy statement was ‘talking down the economy,’ and went onto say that expectations for another round of quantitative easing is ‘wishful thinking’ as the recovery gathers pace. The less dovish stance held by the central bank should prop up the USD going forward, and the index looks poised to work its way back towards the 61.8 percent Fibonacci retracement around 9,949 as index finds intraday support around the 50.0 percent Fib around 9,830.

All four components advanced against the greenback, led by a 0.49 percent rally in the Australian dollar, but the technical outlook for the high-yielding currency instills a bearish forecast for the AUD/USD as the pair breaks out of the upward trending channel from earlier this year. As the AUD/USD struggles to hold above 1.0700, a close below the 20-Day SMA (1.0705) could pave the way for a move lower, and we may see the exchange rate fall back towards the 23.6 percent Fib from the 2010 low to the 2011 high around 1.0350-60 as it appears to carving out a top around 1.0800. However, as the aussie-dollar maintains the range from earlier this month, the exchange rate may continue to move sideways before we see a meaningful break in the exchange rate, and the pair may preserve the 200pip range going into the following week as market participation tends to thin ahead of the weekend.

AUD

Has the Australian dollar called time on European equities’ rally?

Perhaps. The AUD/USD pair has had a long positive correlation with Euro Stoxx futures, going back more than six months. This seems reasonable enough as both fit neatly into the “risk asset” category of markets that are likely to rise when investors feel a bit happier about the economic future.

Moreover, as perhaps the “risk on” asset par excellence, the Aussie is more closely correlated with European stocks than other markets you might think were more natural Euro Stoxx bedfellows, such as EUR/USD or German bund yields.

However, according to Paul Day, chief strategist at Market Securities in London, in the past couple of weeks there have been signs of divergence. Euro Stoxx futures have edged upward even as AUD/USD has made technical analysts nervous with the ominous pattern of “lower highs and lower lows” that usually marks a change in bull-market fortunes.

And there are others who think the Aussie is looking dizzy at its current altitude.

Morgan Stanley points to weakness in the Chinese export order index.

“This provides further evidence that demand in developed markets remains weak, which should not bode well for the high-beta commodity currencies,” the bank’s foreign exchange strategists wrote.

However, they don’t expect an AUD collapse, or anything like one; rather a correction of recent gains. The bank is looking for a return to the $1.05 to $1.0450 area in the near term. The pair was at $1.0633 at 0645 ET Wednesday.

If they are right, correlations suggest that the road for European stocks may get rougher, but it should at least remain passable.

AUD/NZD

A morning foreign exchange rate note from Barclays Capital has noted that the investment banks fair value model suggests the downside risk to the AUD/NZD is likely to be limited and the bank therefore maintain their medium-term forecast of 1.26.

Relative Australia and New Zealand data and likely interest rate trajectories point to further downside in Australian dollar / New Zealand Dollar from current levels.

New Zealand data have, on average, beaten expectations more often than Australian data in recent months, pointing to the risk of a fall in AUD/NZD to around 1.25 by end-March. 

USD/AUD

The Dow Jones-FXCM U.S. Dollar Index remains 0.21 percent higher from the open after moving 79 percent of its average true range, and we may see the greenback track sideways over near-term as it breaks out of the upward trending channel from earlier this month. As the 30-minute relative strength index falls back from a high of 66, we should see the USD hold within the Bollinger Bands going into the middle of the week, but the fundamental developments coming out of the world’s largest economy may prop up the reserve currency as the more robust recovery dampens the scope for another round of quantitative easing.

As the USDOLLAR struggles to hold above the 50.0 percent Fibonacci retracement around 9,830, the failed run at the 50-Day SMA (9,888) could produce a short-term correction in the index, and we may see the index fall back towards the 38.2 percent Fib around 9,710 as market sentiment picks up. However, as the economic docket is expected to show a more robust recovery in the U.S., we may see the greenback may extend the rebound from 9,672, and the reserve currency may continue to recoup the losses from earlier this year as the Fed has limited scope to push through another large-scale asset purchase program. In turn, the dollar index could be putting in a higher low around 9,800, and we will be looking for additional USD strength as the central bank softens its dovish tone for monetary policy.

Three of the four components weakened against the greenback, led by a 0.62 percent decline in the Australian dollar, but we may see the high-yielding currency trend higher over the next 24-hours of trading as market sentiment improves. Indeed, it looks as though currency traders are betting on a short-term reversal as the AUD/USD threatens the upward trending channel carried over from the previous year, and the pair looks to be carving out a major top in February as there appears to be a bearish divergence in the relative strength index. However, we anticipate to see higher prices should the pair continue to close above the 20-Day SMA at 1.0702, and the aussie-dollar may consolidate before we finally get a short-term correction in the exchange rate.

AUD

The RBA release the minutes of its February monetary policy meeting at which it left official interest rates on hold.

The Australian dollar is slightly lower ahead of the outcome of the euro zone finance ministers meeting in Brussels. The European ministers, at a two-day meeting, are expected to approve the delivery of the second bailout package for Greece to save the country from bankruptcy.

At 7am AEDT on Tuesday, the Australian dollar was trading at $US1.0745, down from $US1.0771 on Monday. A failure in Greece could see the AUD down to the 1.05 level.

Dutch Finance Minister Jan Kees De Jager demanded the European Union and the International Monetary Fund take “permanent” control of government decision-making over revenues and public expenditure in Greece.

De Jager said partners committed to providing Greece money for years to come need “some kind of permanent presence” dictating policy on the ground, adding “it is very important when you loan money that you are the boss.”

AUD

The Australian dollar pared the decline from earlier this month amid the slew of positive developments coming out of the $1T economy, but the high-yielding currency may struggle to hold its ground next week should the Reserve Bank of Australia’s meeting minutes fuel speculation for more rate cuts. Although the RBA surprised the market by keeping the benchmark interest rate at 4.25%, the central bank may continue to strike a dovish tone for monetary policy as the board curbs its outlook for growth and inflation.

Indeed, Deputy Governor Philip Lowe held a cautious tone for the region, noting that ‘businesses are scaling back their operations in Australia and some are closing down,’ while Assistant Governor Guy Debelle warned that ‘uncertainty is likely to persist for some time to come’ in light of the ongoing turmoil within the world financial system. As commercial banks in Australia remain reluctant to pass on slew of rate cuts from the previous year, the RBA may see scope to ease monetary policy further, and Governor Glenn Stevens may sound increasingly dovish next week as he’s scheduled to testify before the House of Representatives Standing Committee on Economics on Thursday at 22:30 GMT. Nevertheless, market participants appear to be scaling back bets for lower borrowing costs as Credit Suisse overnight index swaps now reflect expectations for 50bp worth of rate cuts over the next 12-months, but we may see interest rate expectations deteriorate next week should the RBA see scope to cut borrowing costs further in 2012.

The failed test of 1.0800 casts a bearish outlook for the AUD/USD and we may see the exchange rate continue to carve out a top next week as it threatens the upward trending channel carried over from the previous year. In turn, we will keep a close eye on the 20-Day SMA (1.0681) as it holds up as support, but a close below the moving average should lead to a short-term reversal as the relative strength index continues to come off of overbought territory

AUD

FXstreet.com (San Francisco) - The Australian dollar rose against the greenback on Thursday as stronger than expected fundamental data from the U.S. and optimism over a Greek deal lifted risk sentiment. 


"[AUD/USD] Hourly chart shows indicators losing early strength holding in positive territory, while price consolidates in a tight range, supporting further gains more if local share markets follow the European and American lead," explains Valeria Bednarik, Chief Analyst at FXstreet.com. "In bigger time frames, price goes back and forward around a flat 20 SMA since past Tuesday, while indicators regain their midlines, supporting the bullish tone, limited for now as long as below mentioned static resistance level." 


AUD/USD is steady around 1.0750 in early Asia, with support levels noted at 1.0725, 1.0690 and 1.0650, while resistance levels lie at 1.0770, 1.0810 and 1.0850.

AUD

The Australian Dollar was higher against the U.S. Dollar on Thursday after the release of Australian data on Employment Change.

AUD/USD was trading at 1.0719, up 0.22% at time of writing.

The pair was likely to find support at 1.0630, Tuesday’s low, and resistance at 1.0778, Monday’s high.

Earlier in the day, official data showed that Australian employment change rose more-than-expected to a seasonally adjusted 46.3K last month from -35.6K in the preceding month whose figure was revised down from -29.3K.

Analysts had expected Australian employment change to rise 10.9K last month.

Meanwhile, the Australian Dollar was up against the Euro and the Japanese Yen, with EUR/AUD shedding 0.43% to hit 1.2163 and AUD/JPY rising 0.27% to hit 84.11.

AUD

The overnight currency sessions were littered with significant economic data but it was the ongoing influences that drove the majority of market direction.  Greece's austerity measures still remain on the table with European finance ministers to hold a teleconference with Greece in regard to the bailout fund and if they are making enough cuts and the surety of the cuts being made.  Greece's long history of broken promises on reform and the impending election is weighing on the European Union.   The European session however was surprisingly positive following yesterday's rating cuts and warnings from Moody's with the Euro trading through 1.32 USD as a confident Italian bond sale helped illustrate that the Greek issues may be localised. These gains were then quickly unwound following the US retail sales print a few hours later.  US retail sales came in at 0.4% versus median expectation of 0.8% and this drove strong US dollar demand for the rest of the night.

Yesterday's surprise Bank of Japan Quantitative Easing expansion also insulated the Yen from the safety play trade, depreciating versus the US dollar after the retail sales print, where ordinarily you would have expected the opposite.  After the BOJ added a further 10 trillion Yen which it will purchase Japanese government bonds with, the US dollar surged past 78 yen where it last traded 31 October post intervention.  The BOJ also announced that its inflation target will be 1%, as it tries to shrug of deflations concerns while helping boost the economy.

Analysts were spot on with UK inflation expectations which came in at 3.6% from last month's annualised 4.2% print.  One of the reasons for the fall was value added tax (VAT) rise was no longer effecting the figure following last year's move from 17.5% to 20%.  The large drop still sees inflation above target of 2% since 2009 but in his letter to the Chancellor Mervyn King wrote that "The Committee's best collective judgement is that CPI inflation will continue to fall back to around the target by the end of 2012."  The data itself did little to influence the Pound, with Greek concerns and US retail sales seeing the Pound now have given up all of February's gains trading down to 1.5644 USD.

The Australian dollar this morning welcomed a late rally on Wall Street and has clawed back some of overnights losses.  The Australia dollar sits 35 pips from where it traded pre US retails sales print, recovering over 50 pips in the last 120 minutes of the US session.
 

Aud Movement

The Dow Jones-FXCM U.S. Dollar Index remains 0.39 percent lower from the open after moving 73 percent of its average true range, but we should see the rebound from 9,672 gather pace as the greenback finally breaks out of the downward trending channel carried over from the previous month. As retail spending in the world’s largest economy is expected to increase another 0.8% in January, the ongoing expansion in private sector consumption should dampen expectations for additional monetary support, and we may see the FOMC soften its dovish tone for monetary policy as the recovery gradually gathers pace. In turn, the developments on tap for this week should increase the appeal of the USD, but we may see a growing rift within the committee as the pickup in growth raises the prospects for inflation.

As the USDOLLAR bounces back from the 10-Day SMA (9,729), the greenback looks poised to strengthen further over the next 24-hours of trading, and we anticipate to see the index make a run at the 50.0 percent Fibonacci retracement around 9,830 following the failed test of the November low (9,665). As the FOMC is scheduled to release its policy meeting minutes later this week, the remarks could highlight an improved outlook for the U.S. economy, and we may see the central bank endorse a wait-and-see approach for the first-half of 2012 the risk of a double-dip recession subsides. However, as Fed Chairman Ben Bernanke keeps the door open to expand the balance sheet further, speculation for another round of quantitative easing could push the index sideways over the coming days, and we may see the USD consolidate further before we eventually see it retrace the decline from earlier this year.

All four components advanced against the USD on Monday, led by a 0.67 percent rally in the Australian dollar, but the AUD/USD may struggle to hold its ground should it close below the 10-Day SMA (1.0730) for the second day. As the upward trend in the aussie-dollar appears to be giving it, the pair looks poised to give back the rally carried over from the end of 2011, and we may see an aggressive move to the downside as the relative strength index finally falls back from oversold territory. In turn, we should see the exchange rate fall back to the 23.6 percent Fib from the 2010 low to the 2011 high around 1.0350-60 to test for near-term support, but the see the AUD/USD may consolidate further as the developments coming out of the euro-area props up market sentiment.

NZD

The New Zealand dollar fell against the greenback in the New York session on Friday, dropping well below the US83 cent level with markets nervous that the latest Greek austerity package could unravel when it's put to a parliamentary vote.

The kiwi recently traded at US82.58c, down from up from US82.58c at 5pm on Friday, snapping a two month rally. On the Trade Weighted Index of major trading partners' currencies it fell to 72.68 from 72.88.

The optimism surrounding the Greek austerity and debt swap deal appeared to run out of steam on Friday amid reports that the leader of Greece's far-right LAOS party, George Karatzaferis, would refuse to vote in favour of the measure. The party is part of the current governing coalition.

That sparked fears in the market that the deal could run into headwinds when it's placed before parliament later today, triggering a sharp slide in the euro, as well as growth currencies such as the kiwi and Australian dollar.

The sobering mood spread to equity markets, with the Standard & Poor's 500 Index posting its first weekly decline in five straight weeks, falling 0.2 per cent to 1342.64 on Friday. Meanwhile in Europe, the Stoxx 600 Index closed 0.9 per cent lower at 261.24.

"Offshore direction will be critical for the moves of the NZD this week," said Alex Sinton, a senior dealer at ANZ New Zealand. "Initially it should look to the hourly support channel around 82.34c as markets start to realise that implementation of the Greek bailout measures will be much harder than first thought."

On the crosses, the kiwi recently traded at 77.38 Australian cents, little changed from77.39 on Friday, and it fell to 64.10 yen from 64.42 yen. It was little changed at 62.57 euro cents, from 62.55 euro cents previously, and fell to 52.45 pence from 52.52 pence at 5pm on Friday.

The kiwi may trade between US82.34c and US82.94c today, Sinton said, with further declines likely.

AUD

The Australian Dollar was higher against the U.S. Dollar on Monday after the release of Australian data on Home Loans.

AUD/USD was trading at 1.0690, up 0.16% at time of writing.

The pair was likely to find support at 1.0640, Friday’s low, and resistance at 1.0844, Wednesday’s high.

Earlier in the day, official data showed that The number of new home loans granted in Australia rose more-than-expected to a seasonally adjusted 2.3% last month from 1.8% in the preceding month whose figure was revised up from 1.4%.

Analysts had expected Australian home loans to rise 1.9% last month.

Meanwhile, the Australian Dollar was up against the Euro and the Japanese Yen, with EUR/AUD shedding 0.05% to hit 1.2360 and AUD/JPY rising 0.28% to hit 83.07.

Aud

The pound Australian dollar exchange rate is 0.07% higher with GBP/AUD at 1.4664, the pound New Zealand dollar exchange rate is 0.03% lower with GBP/NZD at 1.8936.

A surprisingly high Chinese inflation figure failed to weigh on the Australian dollar, which remains firm.

"High Chinese inflation (back up at 4.5%) reduces the scope for monetary easing and therefore weighs on the country’s growth outlook and demand for Australian commodities. Still, the aussie dollar marched on, with the market convinced that the spike in inflation will prove temporary, says a morning exchange rate note from the team at Caxton Fx.