Currency War Myths And Trades

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About: WisdomTree Emerging Currency ETF (CEW), Includes: FXE, FXF, FXY
by: Michael A. Gayed, CFA
Summary

The prevailing opinion is that emerging market currency has been hit hardest as investors’ risk appetite has declined.

The hypothesis that developed market currencies are suffering less from the trade war than emerging market currencies seems to be sound.

If recent history has taught us anything, it is that US-China trade relations can improve or deteriorate without any prior warning.

Due to current economic conditions, the light at the end of the tunnel has been turned off. – Currently Everyone

As the trade war heats up, and non-USD currencies have depreciated, the prevailing opinion is that emerging market currency has been hit hardest as investors’ risk appetite has declined. But is this opinion based on fact? As a way to test this opinion, 2 ETFs are used: the Invesco CurrencyShares® Euro Currency (FXE) as a proxy for developed, non-US markets’ currency performance and the WisdomTree Emerging Currency Strat ETF (CEW) as a proxy for emerging market currency performance.

On June 29, 2019, American and China agreed to restart trade talks. These talks were the most recent highpoint in the ongoing trade war with both emerging market and developed market currencies appreciating the next trading day. However, this optimism was short-lived, and since August, there has been a progressive decline in both emerging and developed markets currency relative to the US dollar.

The depreciation in the Invesco CurrencyShares® Euro Currency ETF over this period has been 3.1%, while the depreciation in the WisdomTree Emerging Currency Strat ETF has been 2.8%. This result goes counter to the argument that emerging market currencies are suffering more. However, the Eurozone has suffered from problems of its own, including, but not only, the ongoing Brexit process. It might, therefore, be a Europe specific issue. To ensure that it was not due to Euro-specific problems, the Invesco CurrencyShares® Japanese Yen ETF (FXY) has been used to measure the performance of another significant developed market. Unlike the Euro, the Japanese Yen has appreciated by 1.3% over that period. This result suggests that the reason for the underperformance of the Euro has been due to the political uncertainty caused by Brexit and that the hypothesis that developed market currencies are weathering the storm better than emerging market currencies is sound.

Finally, there is one other currency ETF that is worth looking at: the Invesco CurrencyShares® Swiss Franc ETF (FXF). As the Swiss Franc is not mainly influenced by the Swiss political and economic climate, it is a good proxy of the general performance of less risky currencies. It has also depreciated against the USD, but only by 0.8%, a substantially lower rate than the Euro or emerging market currencies.

As a result of the data, the hypothesis that developed market currencies are suffering less from the trade war than emerging market currencies seems to be sound, excluding Europe, which has its area-specific political uncertainty. In terms of trading strategy, there are some possible ideas that could be used. If one feels that the trade war is winding down, then now would be an excellent opportunity to buy into emerging market currencies, such as through the WisdomTree Emerging Currency Strat ETF. However, if recent history has taught us anything, it is that US-China trade relations can improve or deteriorate without any prior warning. As such, parking one’s investments in the currency of a stable developed market, such as Japan or Switzerland through the Invesco CurrencyShares® ETFs would appear to be prudent. Europe, until Brexit has been addressed, still seems to be an area that should be avoided.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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