Hyips & Forex

The rally in emerging markets and accompanying revival of the carry trade can be seen clearly in the Hungarian Forint, which can now claim the distinction of being the world’s best performing currency. You’re probably scratching your head and/or rolling your eyes, but bear with me.

Beginning last July, shortly before the peak of the credit crisis, the Forint began to fall rapidly. It quickly lost more than half of its value against the Dollar, but then again so did a bunch of other currencies. The more relevant comparison is with the Euro, against which the Hungarian currency also fared quite poorly. Despite a 13% rally over the last two months, the Forint is still down 27% from its high last summer.

This is understandable, since Hungarian economic fundamenals are commensurately poor. “Household consumption is shrinking due to a drop in wages and narrower borrowing opportunities, while investments are hit by a lack of funds and a global economic downturn.” Factor in an 18.7% annualized decline in exports, and the result is a 6.4% decline in GDP for the most recent quarter.

Hungary’s economic woes have not gone unnoticed. “The International Monetary Fund, the EU and the World Bank have pledged 20 billion euros ($27 billion) of emergency loans to support Hungary, the biggest aid package for a European nation alongside Romania.” While financial markets have stabilized, credit default swap rates indicate investors are still concerned about the possibility of default. Meanwhile, Hungary has now been officially rejected (for the second time) by the European Monetary Union, such that its doubtful that Forint will ever be absorbed into the Euro.

Why, then, is the Forint rallying? The answer is simple: high interest rates. The benchmark Hungarian interest rate is a lofty 9.5%. While other Central Banks have been busy lowering rates to try to boost economic growth, “The Monetary Council of the central bank voted unanimously on April 20 to keep rates on hold at 9.50 percent.” Given the precarious financial situation, its economic policymakers are concerned that a drop in interest rates could precipitate capital flight and a currency crisis.

An exasperated Deputy Central Bank Governor explained to reporters, “As long as Hungary is considered such a vulnerable country, our interest rates cannot be lower than South Africa’s or Turkey’s; it’s not the Czech Republic, Slovakia or Poland you should compare us to.” She has clearly been paying monitoring the forex markets and knows that now is not the time to gamble with investors’ sudden return to Hungary.

Analysts remain divided over whether the upward trend in the Forint is sustainable. For its part, “Deutsche Bank recommends investors sell the euro against the forint on bets the rate difference will help the Hungarian currency gain 10 percent to 260 per euro in two to three months from 286.55 today.” However, it will be difficult for the economy to stage a serious economy for as long as the currency is rallying, which is why a survey of analysts revealed a median forecast of a medium-term decline in the Forint.

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A steady decline in risk aversion has taken place over the last few months, such that investors once again appear willing to own riskier assets, especially in the developing world. If this continues, increasing demand for emerging market assets would probably be accompanied by currency appreciation. While there are several ways that investors could conceivably profit from this trend, there is an overlooked strategy: currency options. Specifically, some traders have begun to write “out of the money” put options- the equivalent of selling insurance to investors that wish to protect themselves from further declines in emerging market currencies. Those who specialize in currency options, however, have noticed declines in both implied volatility and the risk-reversal rate, which together suggest that such a possibility is now perceived as less likely. Regardless of whether you plan to employ such a strategy, it’s worth paying attention to currency options prices, as they represent valuable snapshots of a given currency’s perceived health. Bloomberg News reports:

Traders quote implied volatility, a measure of expected price swings, as part of setting options prices. Options are contracts granting the right to buy or sell a specific amount of a security in a given time span.

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The European Union has unveiled an economic stimulus package to match the US, as the two economies continue to mirror each other’s strategies for fighting the credit crisis. Given the evident lack of effectiveness of the US plan, it is no surprise that analysts reacted pessimistically to the policy proposal. At this point, investors and consumers alike appear resigned to the inevitability of economic recession in both economies. In other words, there isn’t much that government can achieve, as their respective efforts will certainly be undermined by increased saving. Besides, investors (including currency traders) remain focused on the financial aspects of the credit crisis, rather than the economic aspects. Accordingly, the theme of risk aversion continues to dominate, as part of a trend that favors the Dollar. Reuters reports:

Analysts said that the plan marked a step in the right direction, but uncertainty about its efficacy, and general concerns about a deep slowdown in the global economy were keeping investors in the mood to sell risky assets.

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