Deutsche launches Asian currency-correlation indexes

Deutsche Bank has launched a set of indexes designed to capture returns generated by the apparent growing co-ordination of currency policy among Asian central banks. They are the first such indexes in the market.

The DB Asia Convergence Indexes simulate a market-neutral strategy that exploits what the German bank believes is an increase in correlation between Asian currencies in up to 12 markets. This trend towards an ‘Asian monetary union’ (AMU) is a result of the widespread use of trade-weighted currency baskets in the region, which Asian central banks appear to use to protect export competitiveness, said Deutsche Bank.

Martin Hohensee, Asia head of fixed income and credit research in Singapore, said: “The concept of an Asian monetary union has been validated by a number of economic studies and is getting serious attention among central banks and exporter groups.

“While obstacles to a formal union remain, the underlying economic rationale seems to be affecting central bank behaviour in Asia. This creates opportunities that are similar to those presented in the early stages of euro convergence.”

According to Deutsche Bank research, the greater use of trade-weighted currency baskets has corresponded with an increase in the correlation between individual Asian exchange rates.

“As correlations increase, intra-regional carry trades become more attractive,” said Hohensee. “With correlations between local Asian currencies nearly perfect, intra-regional carry trades can be more accurately labelled ‘convergence trades’, much like those done in Europe in the 1980s and 1990s during the early approach to European monetary union.”

But unlike the approach to European monetary union, the trend in Asia is not driven by an explicit single policy. Asian currency policy is more informal and adaptive, said Hohensee, which means trading strategies need to be adaptable, adjusting to changing patterns in currency volatility and correlation created by Asian central bank behaviour. “This is the approach we have sought to embed in our indexes,” he added.

Deutsche Bank has also launched two sub-indexes that allow investors to take a more focused view on the AMU trend. The DB Asia Convergence Index – Narrow gives exposure to potential returns generated by this trend in non-Japan Asia, while the DB Asia Convergence Index – Broad gives exposure to the Narrow index plus Australia and Japan, the two markets the bank believes are likely to be most affected by AMU behaviour.

All the indexes can be accessed by buying a note that tracks the indexes, standard options, a note that pays Libor plus the performance of the indexes, or a constant proportion portfolio insurance structure that offers managed exposure to the indexes while providing principal protection.

See also: Foreign exchange - Carry on regardless 
Carry concerns