June 11, 2010
FX news: New dollar index from CME/DJ - a threat to DXY?
Trevor Carr
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Up until now the only dollar index future with tradable liquidity has been the US dollar index future (DXY) traded on the Intercontinental Exchange (ICE). This may now change with the announcement of the Dow Jones CME FX$Index.
The index is expected to launch in the third quarter of 2010, which I imagine means by Labor Day settlement, and will be tradable as a future on the Chicago Mercantile Exchange. The index represents a basket of the most traded CME FX futures (AUD, GBP, CAD, EUR, JPY and CHF) all traded against the USD. The basket weightings are fixed, having been weighted to world trade and rounded for ease of hedging; specifically, 10 FX$Index contracts are equivalent to a basket of currency futures comprising of 4 EUR, 2 GBP, 2 JPY, 1 AUD, 1 CAD, and 1 CHF contracts. The index will be calculated as the basket value divided by USD10,000 and inversely quoted: when USD strengthens against the basket, the index will go down and when the dollar weakens, the index will go up.
The rounded currency weightings are a key point; the CME has foreseen a demand to hedge or unhedge specific currencies within the basket and points out that the index will be cross-margined with the component currency futures.
As Derek Sammann, CME Group’s managing director of FX and interest rate products says in the press release: “Market participants have long shown an interest in trading a basket of currencies against the US dollar as a means of managing their risk. This new contract provides an easier way for customers to more precisely and conveniently lay off global currency risk with a single index. Additionally, portfolio managers can dynamically hedge their positions against the index using the six most liquid currency contracts traded at CME.”
Although ICE’s DXY future trades at quite modest average daily volumes of around $2.5 billion, it has gained traction over the last year and volumes having quadrupled. The weightings of the USDX index, on which the future is based, are unchanged (ignoring the adjustment on the advent of the euro) since the index was created in 1973. However, the index is “highly correlated with the major trade-weighted dollar index”, according to a paper written last year by Marc Chandler at Brown Brothers Harriman. Nevertheless, the manic precision of the weightings (EUR 57.6%, JPY 13.6%, GBP 11.9%, CAD 9.1%, SEK 4.2% and CHF 3.6%) doesn’t lead to any ease of decomposition. And yes, nothing against Sweden, but its inclusion looks a little random.
The ICE future trades 22 hours a day, and options on the futures have been available since March.
In a conference call with the CME’s FX team in London, theweeklyFiX asked if the exchange anticipates that its FX$Index future will undermine ICE’s DXY. Will Patrick, associate director FX products, EMEA, declined to indulge in such speculation, but said: “many prospective users are already connected to Globex [the CME’s electronic trading platform], the CME already provides the most liquid suite of currency contracts globally, and we believe that the FX$Index future, with its ease of hedging and the capital efficiencies of cross-margining, will fill a real demand for the investor community.”
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The CME has tried before to capture $ index products and failed. Dd it mention that in the press release? Liquidity is hard to attract - doesn't mean it won't happen of course and given its success in FX, CME has a good chance. But remember, this is an exahnge which masters in offering solutions looking for problems.
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Lee? Is that you?
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Lee? Is that you?