Anticipating Interventions

You can use Bloomberg tools to spot conditions that may lead central banks to buy or sell currencies, potentially getting an edge on exchange-rate moves.

BY AMIR TAL

Type WIRA <Go> to use the International Reserve Assets function to track changes in central banks’ holdings of currencies.

CENTRAL BANKS INTERVENE IN FOREIGN-EXCHANGE markets when they determine that their currencies are out of alignment with those of other countries. Typically, they’ll intervene because exchange rates are making their nations’ exports too expensive or because liquidity dries up and foreign-exchange-implied interest rates diverge too much from market rates.

Such central bank moves can have big effects on exchange rates. If you could anticipate such actions, you might be able to benefit from currency-related investments or hedges.

Consider Switzerland. The Swiss franc has long been considered a safe-haven currency. As the European debt crisis has unfolded, investors and others piled into Swiss securities and fixed assets, causing the franc to strengthen. In 2011, the Swiss currency gained 21 percent against the euro through Aug. 10, when it traded at 1.03 francs per euro. According to Bloomberg News reports, Swiss companies such as watchmaker Swatch Group AG pressed the Swiss central bank to weaken the currency so that exports would be less expensive. The central bank first cut interest rates and then began buying euros and selling the Swiss currency to hold the franc at a target of 1.20 per euro.

TO CHART THE EURO-FRANC EXCHANGE rate and compare it with the central bank’s holdings of foreign-exchange reserves, type EURCHF <Crncy> GP <Go>. Click on Compare at the top of the screen, tab in to the first field to the right of To, enter 146.055 <Index> and click on IMF Switzerland Foreign Exchange in Millions of USD in the list of matching items. Click on the Update button. The rise in reserves to $317 billion in August 2011 from $233 billion the previous month accompanied a weakening of the franc to 1.20 per euro on Sept. 6.

To access reserves data for countries around the world and track one-month and one-year changes, type WIRA <Go> for the International Reserve Assets function.

Now, let’s take a look at Hungary. Earlier this year, the Hungarian central bank suggested it might have to act if the gap between foreign-exchange-denominated assets and liabilities at local banks widened too much, causing a credit crunch.

To uncover such divergences, you can use the FX Forward Rate Arbitrage (FXFA) function. Foreign-exchange forwards are priced according to an arbitrage-free relationship between interest rates in two currencies and their exchange rate. The basic idea is that you shouldn’t be able to generate a risk-free profit by borrowing in one currency, exchanging into another to lend and then later exchanging back. FXFA in effect compares the yield you could get by lending in the local market to the yield you could get through lending through the currency markets. The function taps market data related to FX swaps, the most commonly used foreign-exchange derivatives, which let banks borrow or lend in another currency by combining a spot and a forward transaction.

To examine the euro–Hungarian forint currency pair, type FXFA EURHUF <Go>. If there’s a check mark in the box to the left of Via, click on it to deselect the feature that lets you calculate cross rates through a third currency.

To display the cost of borrowing euros through the FX swap market, click on the arrow to the right of Trade View and select Borrow EUR. As of June 11, the implied cost of borrowing euros for one year via a swap was about 3 percent versus a rate of 0.9 percent as derived from the euro yield curve. Click on EUR Yield Ask and then on View/Edit Curve to see the euro yield curve used in the calculation.

Hungary’s central bank said in an April 26 report that it was concerned local lenders were relying too heavily on funding that gap with FX swaps, bringing forint-implied yields lower. Yields that are too low may weaken the currency because it costs less to short it, which in turn causes the gap to widen. That can increase funding pressure. Should the forint depreciate, lenders would need to pay more FX collateral on their foreign-exchange-swap funding.

The other side of the equation shows the implied interest rates of the forint. The more expensive it is to borrow euros via an FX swap, the cheaper it is to borrow forints. Press <Menu>, click on the arrow to the right of Trade View and select Borrow HUF. As of June 11, FXFA showed that the one-year foreign-exchange-implied yield of the forint was 5.4 percent, compared with a 7.4 percent market rate. That 2-percentage-point spread wasn’t as wide as it had been: On Jan. 16, it was about 3 percentage points. If implied rates and the spread with market rates returned to those levels, the central bank might take action.

ANOTHER POTENTIAL TRIGGER FOR CENTRAL bank action is currency volatility. The Indian rupee dropped 4.9 percent against the U.S. dollar this year to trade at 55.83 rupees per dollar on June 11. That was weaker than levels that prompted the Reserve Bank of India to intervene in currency markets in December.

To compare the level of the rupee spot rate with its volatility, type USDINR <Crncy> VOLC <Go> for the Volatility Comparison function. Click on the first arrow under Measure and select Spot. Next, click on the second arrow under Measure and select Realized Vol. (Daily). Click on the arrow to the right, under Term, and select 1 Month. Click on the first and second arrows under Lag and select 0 Day.

To chart data for the past year, click on the arrow to the right of Period and select 12 Months. After trading near 44 rupees per dollar in July 2011, the currency fell 20 percent in six months amid concerns over Europe’s debt crisis. The dollar-rupee spot rate reached 53.70 on Dec. 14, and two days later, volatility hit 14.86 percent. The bank cited volatility as its main reason to intervene.

AMIR TAL IS A FOREIGN-EXCHANGE APPLICATION SPECIALIST AT BLOOMBERG IN NEW YORK. This email address is being protected from spambots. You need JavaScript enabled to view it.

TIP BOX

Type NI CBINTER <Go> for headlines of news stories related to interventions.

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