Daily News | Oct 19, 2018 | 1
Could the forint become the new Swiss franc?
According to portfolio.hu, more and more analyzers mention that the status of forint might change on the international foreign currency market: it could become a funding currency from the former carry currency. But what does this mean in practice? Would it strengthen the forint? And would it be good for us?
What happened to the forint?
It’s been mentioned quite a lot in international analyses that the international role of forint is going through a drastic change: it is becoming a funding currency from being a carry currency. But what is a funding currency? In the so called carry trade business, the investors get a loan in a currency of low interest, and then invest the money into a high-yield project. This way they increase their profit but also accept the risk of the exchange rate.
The carry trade businesses weaken the funding currency in the short-run, because loan is taken out in the given currency (short position). But if these short positions get snapped by investors, then the funding currency gets too big of a boost.
So the funding currency is characterised by low interest rate, this is partly why forint became attractive beside the 0.9% prime interest rate, which is considered low even on the emerging markets. The Hungarian National Bank decided to further boost this with non-conventional tools, thanks to which money-market interest rates are around 0%.
The significance of carry trade businesses is that they produce a high yield for years, but they can lead to losing the cumulated profit of many years in turbulent periods. Because currencies of high interest rate go through long upvaluation periods, which are cut off by sudden deadening.
The most popular funding currencies of the past years and decades have been the Japanese yen and the Swiss franc. At one point, the latter started thriving drastically, so the central bank had to intervene. A similar phenomenon happened in the region with the Czech koruna.
Will everyone fight for the forint?
It’s hard to tell where the forint’s transition is currently at, because there are no statistics about the new positions on the market. However, rumour has it that some investors have already jumped at the opportunity. In the case of forint, this could also mean inland trade beside the traditional carry trade business.
For instance, certain investors buy 10-year Hungarian fund from sources of low interest rate or even negative interest rate. This way they can still achieve a yearly yield over 2.5%.
The forint interest of currency exchange business can even reach a negative range among the current market conditions. And the exchange rate is stable, so there’s no need to worry about potential rate loss. This attracted the attention of several investors, who switched to using forint as a funding currency.
The transition goes together with the change of the investors’ circle on the market. Among foreigners, there are more and more leveraged investors, who trade from credit. Parallelly, the rate of traditional investors is decreasing.
The trade of the forint market
The traffic data of the Hungarian National Bank back up the statements written above. For example, the daily average traffic of the euro-forint spot market is almost at the lowest rate ever, which means that investors mainly finance their positions through swaps.
The same statistics also tell about the change of the investors’ circle: the relapsing traffic on the spot market is mainly due to the decreasing activity of foreign banks. Meanwhile, the share of other resident investors is stagnating.
On the other hand, the swap market plays a more and more important role, and the traffic of the dollar-forint quotation is getting bigger. The aggregated euro-forint and dollar-forint swap traffic accounts for the 74.2% of the total traffic on the forint market, which is the highest rate in the past five years.
Is this dangerous?
As mentioned above, traditional funding currencies frequently go together with constant upvaluation pressure, which was exactly why Swiss and Czech central banks had to intervene into the market process. The reason behind this is that investors get loans in funding currency, but when they want to shut down their positions, they have to buy the given currency on the market. And if this happens in a big amount, it generates constant demand.
For now, this doesn’t endanger the forint, because it’s not used as a funding currency widely. We’re probably in the beginning of the process as these investments are mainly financed from swap positions.
Consequently, the exchange rate effect mentioned above doesn’t occur, since these swaps already have an expiration rate at the time of the transaction.
The question is whether or not the current tendency will last in the future. If investors switched to the spot market from swaps, then the excessive rise of the currency could pose a threat. But for now, the market prefers swaps due to their attractive pricing. However, a lot can depend on what kind of actors want to trade with forint in the future.
Featured image: Daily News Hungary