FX reserves and alpha


It is often commented that the presence of non-profit maximising participants in the foreign exchange market (tourists, central banks) opens up doors of opportunity, or profit, for currency traders; the prime example being when Soros ‘broke the Bank of England’ in 1992.

The above chart, from The Economist, underscores the extent to which central banks are hoarding foreign currency, a byproduct of past and present efforts by author-ties to artificially influence exchange rates and possibly exports. Japan hasn’t intervened in the fx markets for some time, but China’s reserves now exceed a trillion dollars and they continue to balloon while China maintains an artificial exchange rate. Although it isn’t a universally held belief, the potential distortion to market prices is widely thought to imply scope for the USD to depreciate over time and for the Asian currencies to appreciate.

Is this an alpha opportunity? Perhaps. Some say that fx trading is a pure-alpha play, that all returns are due to the skill of the manager, and that there is no beta (systematic return) in the market. Others believe beta is present in the form of the carry trade, trending, and a currency’s tendency to reverts its to fundamental value over time. Indeed, Deutsche Bank recently launched an index along these lines, marketing it as the first attempt to deliver beta to the market in the form of an index. Personally, I’m not as comfortable with the concept of beta and alpha in the fx market as in markets (equities, bonds, commodities). Also, these concepts, while interesting, hold more relevance for the portfolio manager than the individual trader. Indeed, I’ll be happy with any kind of return!

3 responses to “FX reserves and alpha

  1. Indeed, I’ll be happy with any kind of return!

    Can I get an Amen, brother!

  2. Pingback: Good to Go Pile . . . « Trading for the Masses

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