FX – Circle of Incompetence

This will never work (Vol. 5, No. 28)
When you try to do somethings outside your circle of competence

I hate foreign currencies (FX). Every time that I tried switching between the different currencies, I have lost money. In the FX arena, I am a 100% contrarian indicator.

My one saving grace is that I recognise my limitations and have tried to steer clear of any FX-related decisions since 2016.

Got a trip to the Europe/UK/Japan coming up? Should we take advantage of the EUR/GBP/JPY weakness and buy some ahead of time? No thanks. Compared to my own folly, Mastercard’s 2-3% spread is nothing.

Sometimes Trouble Finds You

Given my FX incompetence, I try to keep all my holdings in my local currency – in this case, the HK$ and US$.

Alas, life is not so simple, sometimes, trouble finds you.

Here’s the situation. A family member needs to top up some of the HKD in their bank account. They can either (i) convert it from their EUR, GBP or AUD deposit, (ii) let a HKD time deposit mature and move it to savings, or (iii) let a Rmb time deposit mature and convert that to HKD.

Carry? The Interest Rate Differential

From a carry perspective, the first option of converting some EUR/GBP/AUD would seem to make the most sense. At Hang Seng Bank, one of the stingiest deposit payers, the 1.2% and 0.8% that it pays on AUD and GBP is much lower than the 2.3% that it pays on HKD. With the EUR still yielding 0%, from a carry perspective, any conversion should be from the EUR.

Sounds straight forward? Not so fast.

Although switching from EUR to HKD would allow us to gain some 2.3% a year , we would getting out of the EUR at its weakest level in 20+ years. Any income that we gain would be lost if the EUR just bounces a few percent.

With the benefit of hindsight, the best time to switch out of the EUR was back in 2008 and not when it is now 38% lower. That said, with the current narrative (EU dire economic outlook and Fed still leading the ECB in hiking rates), the EUR could also fall even lower.

You see why I hate FX decision.

Option #3 – Roll Off Rmb Time Deposit

The second option of allowing the HKD time deposit to mature is the only one that does not involve FX. What we would be giving up is the 2.3% interest, which is likely to increase as HK$ rates follow US rates higher.

This leaves us with Option #3.

Should we let our Rmb time deposit roll off and convert that instead. At present, the 2.0% Rmb time deposit rate does not look all that attractive compared to US$ (3.2%) and HK$ (2.3%).

Before we decide, we need to consider some historical context.

Rewind back to 2020, Covid was rampaging through the global economy. The US and most Western economies were near total shutdown. Facing such dire outlook, the West enacted huge fiscal stimulus along with unprecedented monetary easing. This was supposed to destroy their currencies.

At that time, China was the only country not to pursue unconventional monetary policy and the Rmb was the only currency to offer positive interest rates.

This was the right call for a while but as soon as the US went into hiking mode, what we gained in carry was more than lost in FX as the Rmb fell -6.6% over the past two years.

Although the decision to hold Rmb resulted in a loss, what about the alternative?

Over the same period, the EUR is down -16%.

The AUD is down -12% and …

…the NZD is down -16%.

What Could Go Wrong?

I hate making FX decisions.

Knowing full well that whatever we decide this time is going to turn out wrong, we should choose the one that we can at least explain two years down the line. At present, with all the other currencies hiking rates and only one cutting, option 3 is the simplest answer.

This has never worked.

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