The reams of articles published every day in the financial media improve market transparency, still, newcomers should be aware that unseen trading and investing news can have a strong impact on price trends.
The immense spending power of central banks and hedge funds means that their influence on the markets is significant. These two market participants have trillions of US Dollars to invest to deepen or reverse market trends, sometimes confounding millions of other traders with the outcomes.
The news share of these heavyweights is lower profile than other market news like earnings or macroeconomic announcements. Central banks tend to issue complex statements about their market activities and unless a hedge fund is a publicly listed entity, the daily investments from this sector are less transparent than other market factors.
What this boils down to is that the news comes after the events and can catch traders off guard.
Most notably in the current economic conditions of diverging monetary policies between the Bank of Japan (BoJ) and the Federal Reserve, the USD reached such high levels versus the JPY that the BoJ had to intervene to bolster the Yen and calm sentiment.
These types of currency interventions aren’t pre-announced, it’s more a matter of becoming familiar with expected market movements, observation during the event and analyzing the after-the-fact announcement to understand why the JPY strengthened.
During the heat of the trading moment, cool-headed analysis might be out of reach though, underscoring how important risk management is for every trader and investor. Risk management measures such as stop loss orders can prepare traders for unexpected market movements triggered by investments by the heavyweights.
Impact of hedge funds on Treasury bonds
In a bear or bull market, hedge funds have the spending power to amplify any given trend through short selling or mass buying. This can result in considerable disruption of the markets and even have an impact on the wider economy when it comes to currencies and bonds. The European Union’s economy was vulnerable to waves of short selling of sovereign debt before it introduced stricter rules, for example.
Recent research from the Office of Financial Research (OFR) confirmed that hedge fund investments can amplify asset price trends like Treasuries.
“The association between yields and hedge fund demand is economically and statistically significant.” OFR Working Paper ‘Hedge Funds and Treasury Market Price Impact: Evidence from Direct Exposures’.
The state of the secondary market for Treasury securities has a ripple effect on other assets like the USD crosses and stock market sentiment, making the activities of hedge funds a key factor to consider.
Famous example of hedge fund influence
The classic example of hedge fund influence in the currency markets was the 1992 short selling of the GBP by George Soros’ Quantum Fund. During the sell off, the GBP dropped below the peg rate against the German Mark and destabilized the monetary system at the time. Essentially, this was a contest between two heavyweights, the UK’s central Bank of England and a private hedge fund. Central banks became more cautious of currency pegs in the aftermath.
Famous example of central bank intervention
Central banks intervene in the currency markets by buying or selling large amounts of their domestic currency and foreign currencies. There are many reasons for this, starting with a sudden drop in the value of the domestic currency because of market speculation or economic woes. Central banks also build up foreign currency reserves to hedge against economic risks.
A good example of this is the Swiss National Bank’s (SNB) interventions in the Forex market in 2010, when it bought 17 billion EUR in one day to weaken the Swiss Franc against the European common currency. A strong currency can cripple exports and weaken the overall economy, meaning that the strength or weakness of the domestic currency against other currencies is a primary factor for central banks and governments.
Preparing for central bank interventions
How can traders prepare for central bank interventions? The answer is in two parts:
- stay informed about currency movements and economic developments,
- manage risk with stop loss and take profit orders.
Economic and currency conditions are strong drivers of central bank activity, so keeping up to date with their positions is key to preparation. Anticipating unpredictable central bank moves is best backed by careful risk management, especially for newcomers.
Preparing for hedge fund activity
Preparing for private hedge fund activity is difficult, since there are rarely announcements or statements about their investments. Solid risk management and observing when trends deepen because of large and sudden sell offs could go some way to prepare for these situations.
Being aware of the possibility and unpredictability of hedge fund and central bank activity is the first step in managing risk. From there, it’s worth studying institutional investments and learning from experienced traders.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.