Seeking to enhance diversification? Time to explore currency strategies

• Forex strategies rely on a portfolio manager’s ability to exploit differences in the relative values of the world’s major currencies. To do this, specialists combine fundamental analysis and quantitative models to identify the currencies that seem over- or undervalued.

• Forecasting currency movements is highly dependent on understanding the major drivers of FX markets, such as macroeconomic indicators, technical factors and investment flows.

• Going forward, we believe that the major influencing factor will be inflation development and the normalisation adjustments in Central Bank (CB) monetary policies. In general, we think that the USD will weaken further in the medium term due to redirected capital flows, but we could also see some higher volatility and short-term divergences from this trend.

• The benefit of these strategies to an overall portfolio, in our view, is more than just another source of investment return. A portfolio of active currency positions offers a “pure” relative value strategy with low correlation to interest rate or credit markets. This is because investors express relative value views when buying one currency vs another.

• In today’s market, an investment strategy with no correlation to the bond and stock market is invaluable. Quantitative easing has helped to reduce interest rate and credit risk premia, and the danger is that the ongoing normalisation of CB monetary policy will see these risk premia rise together. Currency strategies, with zero correlation to these risks, could help support portfolio diversification, with the additional benefit of being highly liquid.

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