US property market
What could have been a good month for Sterling was spoiled by the US property market. Well it did not happen exactly like that but the connection is valid. As US property prices marched ahead over the last decade, lenders became increasingly creative in the loans that they offered. One area of growth was the “sub prime” market, for people who could not really afford a normal mortgage.
Increased monthly payments meant repossessions
Loans were structured with low monthly payments to start with and much higher ones later on. Borrowers were expected to be able to dodge that situation by re-mortgaging. The slowdown in the US property market made it impossible for some of them to do so and they were saddled with sharply increased monthly payments that they could not afford. It led to repossessions; bad for the homeowner but also bad for the lender. There had been signs for some time that the chickens were coming home to roost and at the end of July it all hit the fan. |
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Mortgage and equity markets affected
A top Wall Street firm announced that its mortgage funds were worthless. Then a couple of mortgage companies admitted that they were effectively bankrupt. It put an almost immediate stop to the whole culture of cheap borrowing, affecting not just the mortgage market but also the mergers and acquisitions that had relied for their success on an endless supply of low cost loans. That had a bad effect on the equity markets for they, too, needed a steady inflow of money to keep them alight.
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Risk aversion top of the agenda
Not for the first time this year, investors started to worry about risk. They started to care more about holding onto their money than making it. This risk aversion permeated the whole financial market and yesterday's no-brainer became today's danger point.
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Using currency exchange rates to your advantage
One of the no-brainers had been the "carry trade", where investors took advantage of the difference between different currencies' interest rates. With Yen rates at 0.75% and others, such as the New Zealand Dollar, at much higher levels (8.25% in that particular case) it was possible to borrow the cheap currency, sell it to buy the other one, and pick up the 7.5% point difference. It was easy money as long as the music kept playing. Sterling was one of the currencies targeted by investors. Rising UK interest rates took the Pound ever further into the realm of the "high-yielder" and the hot money flowed in.
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Currency exchange rate movement meant Sterling suffered
But a play like this only works as long as exchange rates are steady or moving in the right direction. So when the risk balloon went up, the carry trade turned from no-brainer into danger point and everything went into reverse. High-yielding currencies were sold off in order to cover repayment of the cheap borrowings. Sterling suffered less than some but it did suffer. The cent and a half that it had made against the Euro earlier in the month was handed back in short order. By the beginning of August the Pound was exactly where it had been a month earlier.
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Volatile currency market
The whole thing has made investors understandably nervous, and nervous investors do not always make logical decisions. Even if everything settles down in a week or two (and, for the credit market at least, that's not looking likely at the moment), in the short term the nervousness could well mean more volatility in exchange rates. In a situation such as this the crystal ball is far too cloudy to make any sensible assessment of how it will all pan out. So a defensive strategy is called for.
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Currency advice for French property buyers
For those intending to buy a French property later this year, the prudent approach is to buy half of the Euros now, in other words to “hedge” the currency exposure. If the Pound goes down from here you will not be perfectly protected but, if it goes higher, you will not have thrown away the chance to make a windfall saving on the move. A hedge is a compromise. It is not a bet that the Pound will rise or fall, it is an admission that you don't know. (Glossary of terms used in currency exchange.)
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Forward transactions and French property purchases
As the situation becomes clearer you can either hurry to buy the rest of your Euros or hold back and wait. If you buy them "forward", for a settlement date some months in the future, the only money that needs to be paid initially is a deposit, 10% or so. The balance will not be called for until settlement day arrives. (Currency exchange options which save you money.)
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Currency exchange rate movement uncertain
In common with other financial markets, foreign exchange rates are very jumpy at the moment. They might calm down, they might become even more nervous. With your Euro requirement hedged you can avoid some of that nervousness.
Additional articles which may be of interest:
Advantages of using a currency broker or foreign exchange specialist
Currency Exchange - Buying Euros at the Best Rates - Your FAQs
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About the author
The information in this article has been supplied by the currency broker Moneycorp. For further advice on currency exchange and money markets, call Moneycorp today on +44 (0)20 7589 3000. Alternatively go to www.moneycorp.com where you can open a free, no obligation Trading Facility. Make your money go further!
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