First Impressions

Exercising the right to evolve – CME FX options
Craig LeVeille, CME Group

(Editor’s note: This article originally appeared in the “Euromoney FX and Treasury Management Handbook 2014” and is reprinted with permission.)

There has been no shortage of major market influences and central bank actions affecting the FX markets in 2013. Abenomics was one key driving force for the rise in Japanese yen trading, and the continuance of quantitative easing (QE) in the US has made hedgers and speculators realise that currency risk can no longer be an afterthought. Emerging market currencies like the Brazilian real, Indian rupee and South African rand have depreciated in value when talk of QE ‘tapering’ arose, only to be stabilised when Fed remarks indicated that the end of the programme would be at least several months away.

But as many FX venues have seen dramatic decreases in trading volume, CME FX markets have witnessed significant growth in one key area – options. In fact, through early December 2013 our research shows CME FX options volume has grown 48% year over year, with FX open interest 49% higher than levels a year earlier. The growth in options is not too surprising given recent major risk events, like QE tapering discussions and Abenomics. Investors tend to use options as a safer tool to hedge exposures during periods when risks are very difficult to quantify.

However, a closer look at CME’s recent experience suggests that the growth in options may be as much the result of market evolution as it is about volatility. Given the early stage of automation in the global option market, there are strong reasons to be optimistic about future growth prospects.

Click here to read the entire article: http://jlne.ws/1edtOCG (PDF)

Quote of the Day

“There is an obvious tension between using robust fiscal rules to solve this problem, and allowing national fiscal policy to act as a shock absorber. This reinforces the need for fiscal risk-sharing between nations.”

Bank of England governor Mark Carney on how to structure a currency union after Scottish independence.

Lead Stories

Why Uncle Sam needs some novel sweeteners for its bonds
Gillian Tett – FT.com
This week the US government delivered two pieces of noteworthy news. One caused a splash: on Wednesday the Federal Reserve announced another $10bn cut in its monthly bond purchases, the second time it has tapered. Cue Twitter alerts and headlines. But the real drama came a few hours earlier, when Uncle Sam successfully sold $15bn of two-year floating-rate notes to investors in the first innovation in federal debt for 16 years.
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***DA: Floaters, TIPS and other securities that offer both the full faith and credit, plus some price protection. That should keep some punch in the punch bowl for a while post-taper.

Bernanke Secret Sauce Drops Fed Rate as QE Quantified: Economy
Joshua Zumbrun – Bloomberg
Five years into the era of quantitative easing pioneered by departing Federal Reserve Chairman Ben S. Bernanke, two economists say they’ve measured how much extra stimulus the bond purchases provide when the main interest rate is already near zero.
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Abe Doomsday Risk Prompts Moody’s Warning on JGBs: Japan Credit
Finbarr Flynn and Monami Yui – Bloomberg
Moody’s Investors Service says Japan’s biggest banks need to cut bond holdings and boost loans to protect their balance sheets from potential losses should Prime Minister Shinzo Abe’s stimulus spur yield surges.
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India’s Raghuram Rajan hits out at uncoordinated global policy
Robin Harding in Washington, John Aglionby and Delphine Strauss in London, Victor Mallet and Amy Kazmin in New Delhi – FT.com
India‘s central bank governor has hit out at the US and other industrialised countries for running selfish economic policies as their recovery leads to turmoil in emerging markets.
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***DA: All’s fair in love, war and monetary policy.

Emerging Markets Inflow Numbers Point to Exit by Bond Investors
LANDON THOMAS JR. – NYTimes.com
With investors on edge following the recent weeks of turmoil in emerging markets, the release this week of updated capital inflow data by the Institute of International Finance could not have been better timed.
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***DA: Data is either not as bad as expected, or worse, depending on one’s perspective.

Mortgage Volumes Hit Five Year Low
Nick Timiraos – MoneyBeat – WSJ
The volume of home mortgages originated during the fourth quarter fell to its lowest level in five years, according to an analysis published Thursday by Inside Mortgage Finance, an industry newsletter.
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And Here Comes the Turkish Double-Edged Sword
Yeliz Candemir – MoneyBeat – WSJ
Turkey bumped up interest rates massively this week to try and stave off a currency meltdown. Economists pointed to two ramifications of the aggressive rate hike: 1) higher rates should help narrow Turkey’s wide current account deficit 2) but its $800 billion economy is heading for much weaker growth.
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China rate liberalisation to spur onshore IRS market
Aaron Woolner – Risk.net
Interest rate liberalisation in China is already driving rates up – and dealers onshore are bullish that the largest untapped IRS market in Asia will soon burst into life. The question is when?
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***DA: The nation has been quietly building its financial infrastructure, from exchanges to broker-dealers and service providers.

Have EM outflows only just begun?
Izabella Kaminska | FT Alphaville
SocGen’s cross-asset research team believes that when it comes to EM outflows they may have only just begun:
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***DA: If I have that wretched Carpenters song stuck in my head all day I may need to remove sharp objects from the room.

Emerging market strife keeps bond issuers at bay
Andrew Bolger in London and Vivianne Rodrigues in New York – FT.com
The emerging market turmoil that has sent currencies and stocks across the globe sharply lower in the past couple of weeks has also cast clouds over debt capital markets, weighing
on new bond sales.
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Central Banks

Yellen to be sworn in as first woman Fed chair next week
Reuters
Janet Yellen, the first woman to chair the Federal Reserve in its 100-year history, will take over the reins of the U.S. central bank on Saturday and formally be sworn in next week, the Fed said on Thursday.
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A quiet exit from a noisy world
The Economist
After presiding over the Federal Reserve for eight of the most turbulent, crisis-wracked years in its history, Ben Bernanke no doubt hoped to leave on a dull note. It is not to be.
Today was the Fed’s last policy meeting with Mr Bernanke as its chairman, and it did exactly as expected. It reduced its pace of monthly bond buying by $10 billion per month, to $65 billion: $30 billion of mortgage backed securities, and $35 billion of Treasurys. This was the second such tapering since the process began in December.
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Currencies

Dollar Set for Best January Since 2009 as Spending Tops Forecast
Anchalee Worrachate and John Detrixhe – Bloomberg
The dollar headed for its best January since 2009 versus a basket of major peers as consumer spending climbed more than forecast in December, adding to evidence the U.S. economy is growing.
jlne.ws/1fr7raZ

England must reject currency union with Scotland
Martin Wolf – FT.com
Mark Carney, governor of the Bank of England, delivered home truths in Edinburgh this week. The desire of the Scottish government to remain in the sterling area would, he stressed, sharply curtail Scotland’s fiscal and financial independence. What Mr Carney did not note was that the rest of the UK must also have a say in any union.
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Why is the Emerging Markets Turmoil Spreading?
MoneyBeat – WSJ
The pullback from emerging-market currencies continued Thursday, dragging down currencies in central Europe in a development that speaks about a wider malaise across the asset class. The Wall Street Journal’s Europe Markets Editor, Charles Forelle, explains how we got here and what it might tell us about the state of the global economy.
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Currency Defense Depleting Official Treasury Stock, Westpac Says
Candice Zachariahs – Bloomberg
Developing nations have been forced to sell Treasuries and use the proceeds to arrest domestic currency weakness, driving a drop in their custody holdings at the Federal Reserve, according to Westpac Banking Corp.
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2014 forex outlook: The slow decline of the euro
Nordine Naam – FOW
With forecasts pointing to global economic growth of more than 2.5% for 2014, the foreign exchange market will largely be characterised by recovery in the first half of this year. This will be fuelled by the economic prospects of the US and UK in particular, but also to a lesser extent China, where domestic demand is the driving-force of GDP.
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EMERGING MARKETS-Currencies get reprieve as policymakers offer support
Reuters
Emerging markets recovered on Thursday from a sharp selloff as Latin American stocks and currencies rose, while Russia’s rouble and Turkey’s lira rebounded after policymakers pledged to take any necessary measures to stabilize their markets.
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JPMorgan Extols Virtues of Ruble’s Record Plunge: Russia Credit
Ksenia Galouchko – Bloomberg
The ruble’s plunge in this week’s emerging-market selloff holds the promise of more competitive Russian exports and higher budget revenue, JPMorgan Chase & Co.’s asset-management unit and Capital Economics Ltd. said.
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Indexes & Index Products

Freedom Index Co Bows Aussie, Africa Indexes
Faye Kilburn – WatersTechnology
Startup not-for-profit index provider the Freedom Index Company-which launched last year to offer free and independent indexes to the asset management community-is planning to

add Australian indexes to its family of free-of-charge products, and is now seeking donations to support expansion to other markets and asset classes.
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Gold

Taper Trouble Hits Gold’s Fourth Biggest Buyer
Adrian Ash – Forbes
A sharp recovery from Monday’s new all-time lows in the Turkish lira versus the dollar came before the Central Bank of the Republic of Turkey made the announcement that it was hiking interest rates from below 8% to a massive 12% on Tuesday night. The lira has given back half that rally since.
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Identifying Bright Spots in the Choppy Gold Market
Lennox Yieke – The Motley Fool
The record plunge in gold prices in 2013 hurt more than just gold miners’ margins. Amid efforts to safeguard dwindling profits, it became apparent that most gold companies had been mismanaged prior to the unprecedented price drop. Not only did gold miners add high levels of debt in the years leading to the price decline, but no decisive measures were put in place to arrest soaring costs.
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Miscellaneous

Russell Investments’ chief economist found dead in Tacoma
The Associated Press (via The News Tribune)
Russell Investments chief economist Mike Dueker was found dead Thursday, and police said it appeared he had taken his own life by jumping from a ramp near the Tacoma Narrows Bridge.
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