How should I invest using FX futures in 2021? A research-based outlook by CME Group
The United States presidential election has capped off a truly tumultuous year. Weeks after Joe Biden was declared the new president-elect, the current sitting president Donald Trump has yet to concede defeat.
The FX market, on the other hand, had already moved ahead to price in a Biden victory, with the US Dollar weakening against other currencies in expectation of greater stimulus measures and improved international trade relations.
That said, volatility in the FX markets remains high, and the US dollar gained on other currencies with the news of a highly effective experimental Covid-19 vaccine by Pfizer Inc. That enthusiasm was later tempered by the jump in Covid-19 cases in the US and Europe, and the less than optimistic outlook from the Federal Reserve and the European Central Bank.
If you are looking at investing in FX in 2021, these are what you need to know.
What are FX futures? – An explainer
The global forex market is the biggest, most liquid trading market in the world with an average daily trading volume of US$5 trillion. A significant segment of it is traded through FX futures.
FX futures, also known as foreign exchange futures or currency futures, are futures contracts where the underlying commodity is a currency exchange rate. These exchange-traded contracts are agreements to buy or sell a specified amount of a particular currency at a set price and date in the future.
FX futures were introduced in 1972 at the Chicago Mercantile Exchange (now known as the CME Group), after the fixed exchange rate system broke down. Today, FX futures are traded in contract months, with standard maturity dates falling on the third Wednesday of a month typically, the most active ones being the contracts expiring in March, June, September, and December.
What has happened with FX futures in 2020?
So far, the FX futures market has shown strong performance in 2020.
According to CME Group research, average daily volumes (ADV) since the start of the year have risen 0.7% year-on-year to US$75.5billion, with August ADV of US$67.2 billion led by the strong growth of 21.7% in the Euro. EM currency futures such as CNH, MXN, BRL, RUB & ZAR have also shown strong performance so far in 2020.
Open interest in FX Futures recovered to above US$180 billion, after falling to US$150 billion when the Covid-19 pandemic unfolded in March. In fact, large open interest holders are now back above 1,000 (1,099 as of August 25), and is up 16.8% from the 2020 low of 941 on March 24. However, it still has headway to increase given the all-time record of 1,310 on Feb 25.
Open interest indicates the number of contracts that have been entered but not closed out, and is often taken as an indicator of new money entering the market, providing support to current trends.
The EUR/USD pair has also seen a record open interest of over US$121 billion in September, after breaking its open interest barrier for the tenth time in 2020. This arose from CME Group’s 40% to 60% reductions in minimum price increments for the Quarterly Roll for the G5 currencies.
At the same time, the continued activity in EUR and JPY has led to some major client records. For instance, EUR asset managers recorded an all time net long position record on 18 Aug with 337,323 lots, while JPY asset managers recorded an all time net long position record on 25 Aug with 61,326 lots.
In the FX Options market, 2020 has so far recorded the largest-ever single trade in listed FX options – a GBP/USD trade of US$2.2 billion.
“Investors turn to options to manage risk events such as the US election, and in this instance, the Brexit year end transition period deadline ‒ turning to the depth of our liquidity pool and the safety and capital efficiency of our listed FX options in times of uncertainty,” notes the 4Q FX Report by CME Group.
How will FX futures fare in 2021 and beyond?
To understand how FX futures will perform in 2021 and beyond, investors need to look at the biggest driver of FX market trends for 2020: the Covid-19 pandemic.
Blu Putnam, Chief Economist at CME Group, noted that several of the stronger currencies against the US dollar in recent months – particularly the Chinese Yuan, the Euro and the British Pound – had all been affected by the Covid-19 virus but with visibly different results.
“The Chinese Yuan initially weakened during the early stages of the pandemic, until the end of May. From June onward, it became apparent that China had made progress in controlling the virus. The economy came back stronger, and the currency began to gain strength. From June to late September, Chinese yuan had a 6% gain over the US dollar.”
Putnam continued to explain why the picture looked slightly different with the Euro.
“The Euro was initially weak against the US dollar when the pandemic began, because Europe was hit with the virus before the US. Then from a low point on March 20, the Euro rose over 10% through the end of Aug against the US dollar.”
The Euro rally was halted, however, not due to any policy announcement or new economic data, but by the growing evidence of a second wave of the virus taking hold in Spain and France, among other countries. The spread of the virus and its subsequent lockdown measures were expected to negatively impact the region’s economic rebound.
What about the British pound? Putnam noted that the British Pound had been weak against the US Dollar initially, reaching its low point in the second half of March. While the Pound’s subsequent rally eclipsed that of the Euro, it was capped in mid August.
“In the case of the pound there were 2 reasons for the rally’s halt. A second wave of the virus started to appear in the UK dampening its economic outlook. Also, Brexit politics turned more controversial, and the outlook for a negotiated exit deal with Europe became cloudy.”
It may sound too simplistic to blame the fluctuations in FX futures on a healthcare crisis, Putnam has a more rational explanation for it.
“Fundamentals still matter,” he says. “The bottom line is, the virus is still affecting FX markets depending on whether the virus is coming or going, and it’s the economic impact of the virus that creates this effect on FX.”
Trade ideas for 2021
At this time, investors could consider trading GBP crosses (such as the EUR/GBP or GBP/USD) in the light of current Brexit negotiation developments, and what appears to be a stabilising of new Covid-19 cases amid the country’s second lockdown.
The USD/CNH pair could be another area of interest, with China’s retail sales showing robust growth in recent months, particularly in the online space, while the US Dollar continues to see volatility in accordance with the ebb and flows of coronavirus vaccine news.
Over at the Australasia region, the NZD/USD could be another interesting pair to watch. The Reserve Bank of New Zealand appears to be taking a step back from loosening its monetary policy further, as the economy looks to be recovering from its March lows, when Covid-19 first appeared in the country. Lower than expected unemployment rates and a 28% jump in retail sales appear to support this view.
One month left to enjoy Phillip Futures’ US$1.50 promotion to trade CME Group’s Micro E-mini futures contracts
If you are looking to trade gold, or indices, you can consider trading CME Group’s Micro E-mini futures contracts. Sized at one-tenth of a classic E-mini contract, the Micro contracts allow you to trade the futures market with less cash and lower margins.
From now till the end of 2020, investors can trade five CME Micro E-mini futures contracts for just US$1.50 in commissions per side per lot.
To enjoy this promotion, you will first need to be a Phillip Futures customer. Sign up for your trading account easily using MyInfo, receive your approval within a couple of working days and sign up for the US$1.50 commission promotion to get started.