Quote:
Originally Posted by John Kicklighter
Hello Freefox,
Good questions.
The medium term interest rate outlook (which most industrialized central banks target) for both central banks is indeed matching your suggestions. The RBA is expected to shave another 100 basis points off its benchmark and the SNB is expected to keep its target range unchanged through the coming year.
Everything else being equal, we would expect these rate forecast to lead to the Australian dollar depreciating against the franc. However, this isn't an 'everything else being equal' world; so we need to factor in what a fair value for this exchange rate would be before rates were adjusted and after they were adjusted to reflect expectations. Even if the RBA does cut a whole percentage point off its benchmark, it would still be well above the Swiss figure; so there is going to be a point where it comes to equilibrium.
As for introducing commodity prices, that is another, unique pricing dynamic (there are thousands if not millions of different fundamental factors to take into account). Commodities are an important driver for the Australian dollar because the country is one of the largest producers of coal, gold, cattle and many other natural resources; and when you buy those goods from them, you first need to exchange your currency.
However, the correlation holds more closely to those pairs that include major consumers and producers of said commodities. That's why AUDUSD holds such a correlation thanks with the US representing the largest consumer of natural resources. For AUDCHF, that correlation is much weaker.
You definitely need to determine the influence each factor will have on currency pair. AUDCHF is primarily guided by rate expectations - by a wide margin. However, there is still a correlation to commodities; but that is because there is more of a speculation component to commodities as well - as traders use some goods like gold to hedge interest rates and growth.
All that being said, I wouldn't suggest anyone trade a carry in one pair. The leverage could easily force a margin call as capital gains and losses are far greater than any daily carry. Instead, one needs to be diversified in at least 4 (that is a number we have found does most of the diversification) carry trade pairs. But even then, you still have a discretionary call on risk appetite.
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Thanks for that John.
I understand what you mean about the competing fundamentals and the need to somehow quantify the influence each factor will have on the currency pair to determine future projections. I imagine this is where fundamental analysis gets very complicated and hence why there can be differing views as to just what the impact a particular element has.
You mention everything else being equal that a 1% cut by the RBA would lead to the Aussie dollar depreciating against the Franc. I can see that on a carry-trade, with a 100,000 CHF position this would lead to a loss in the interest amount acrued of 1,000 CHF over the course of the year if it was held as Australian dollars. Is my thinking and logic correct here? I know on its own this would be a silly thing to do as it doesn't take into account any capital depreciation, but I'm highlighting it purely as an exercise to understand the mechanics of the carry-trade.
On a further point if my math is correct above, is there a calculation/model that can be applied thats says that for a 1% interest rate cut in one currency (AUD), it can forecast what the exchange deprecation against another currency (CHF) would be? You mentioned about deteriming the influence of each factor and was wondering if that such a model existed to quantify interest rate movements between currencies or are things not as simple as that?
Thanks once again. I do appreciate your time reporting on this thread.
