Macro: Rates and FX

Hi, 

I work in fundamental equities. I like what I do but have always had held a strong interest for global macro. I'd love to learn more about Rates and FX side of the macro strategies. Wondering if anyone could answer some of the following questions to get me started

  1. Banks often lump Rates and FX together. Is this because both asset classes are driven by interest rates, therefore you can cover both with the related/if not the same type of fundamental analysis?

  2. Lots of people in this field seem to have a really quantitative background. Why is this? Are you trying to get edge from your competition by performing complex stochastic/statistical/correlational analysis? Or do you need the quant skills to sift through extensive amount of economic/fundamental data (ie inflation expectations, implied pricing assumptions from swaps/derivs, yield expectations from market etc.)

  3. Does it make sense that if you are good, let's say the top 10% to 20% over a period of 5 to 10 years+, FX and Rates funds are more scalable and the return generated are higher than that of fundamental equities, because even though equities have a higher inherent yield, FX and Rates are deeper markets (tolerant of scaling) and - net of leverage - volatilities (opportunity of profit) are actually higher in FX and Rates than in equities with 3-5x leverage.

  4. I've heard of stories of star trader bringing home 7 to 9 digits, almost always they are rates traders (or sometimes commods guys). What is it about the structure of their trading/payout that allow them such astronamical comps, while those in other assets classes can't get even close?

  5. Just for shits and giggles, how would one transition to FX/Rates from 8 years in fundamental equities?

Much appreciated,

Comments (25)

  • Research Analyst in HF - RelVal
2mo

1. I don't think banks usually lump fx and rates together (i.e., an fx swaps trader wouldn't also be trading govt bonds), but people often do because they're very related as you noted.  Take what's happening in Japan right now, JPY has been selling off because Japanese rates are "too low" compared with the rest of the world.

2. I wouldn't say rates and fx guys have a really quantitative background, but usually more quant-heavy than your typical IB/PE person. My fund employs data scientists and quants to do the heavy lifting on pricing models and whatnot and I wouldn't consider myself a particularly quantitative person. I'm certainly not proficient in stochastic calculus or anything, but to be truly great at trading requires one to be well versed in risk taking and probabilistic thinking. The tools of analysis for macro are python and statistical analysis (regression, PCAs, econometrics, etc.) just like the tools for fundamental equities are excel and financial statement analysis/accounting.

3.  I would tend to agree with you, but a lot of traders also tend to get blown up in short vol carry trades. I think the great part about macro is finding clever ways to express long vol ideas in different markets wherever the risk/reward is the most optimal.

4. Similar to point (3), I don't know about everyone, but many of these guys you see having great years were long vol at the right time. A standard book at a macro fund for a mid-level PM might be $200mm AUM, 10% drawdown limit. With a book like this, it's not impossible to have years where you make $50-100mm or even more if you get lucky. Obviously, this is not the base case, but I think blowout years are more common with this type of structure.

5. I'm probably not qualified to answer this, but I would consider trying to move into a role where you're directly managing risk with a macro-related equities strategy. I believe this is called "thematic investing." The traditional paths to fx/rates are working on the sell-side in trading or research and/or working as a trading assistant/analyst at a macro fund - both of which don't really apply here.

  • Research Analyst in AM - FI
2mo

Agree on last point. Can't think of anyone who went from fundamental equities analyst to fx/rates strat (a handful of ibd to econ phd to macro strat). However, have seen some equity fundamental analyst to macro equity/thematic pm to macro pm/strat as was mentioned. Most likely intuition is understand managing a book, evaluating risk/reward, and have a fx/rates specialist on their team

2mo
halfstep, what's your opinion? Comment below:

Agree on last point. Can't think of anyone who went from fundamental equities analyst to fx/rates strat (a handful of ibd to econ phd to macro strat). However, have seen some equity fundamental analyst to macro equity/thematic pm to macro pm/strat as was mentioned. Most likely intuition is understand managing a book, evaluating risk/reward, and have a fx/rates specialist on their team

Thank you. in your observation of the transition from fundy equity analyst to macro equity PM to macro PM/strat, is the macro PM/strat you are referring to in this instance fx/rates PM? Or do you mean they are equity PM with some fx/rates layering involvement? 

2mo
halfstep, what's your opinion? Comment below:

1. I don't think banks usually lump fx and rates together (i.e., an fx swaps trader wouldn't also be trading govt bonds), but people often do because they're very related as you noted.  Take what's happening in Japan right now, JPY has been selling off because Japanese rates are "too low" compared with the rest of the world.

2. I wouldn't say rates and fx guys have a really quantitative background, but usually more quant-heavy than your typical IB/PE person. My fund employs data scientists and quants to do the heavy lifting on pricing models and whatnot and I wouldn't consider myself a particularly quantitative person. I'm certainly not proficient in stochastic calculus or anything, but to be truly great at trading requires one to be well versed in risk taking and probabilistic thinking. The tools of analysis for macro are python and statistical analysis (regression, PCAs, econometrics, etc.) just like the tools for fundamental equities are excel and financial statement analysis/accounting.

3.  I would tend to agree with you, but a lot of traders also tend to get blown up in short vol carry trades. I think the great part about macro is finding clever ways to express long vol ideas in different markets wherever the risk/reward is the most optimal.

4. Similar to point (3), I don't know about everyone, but many of these guys you see having great years were long vol at the right time. A standard book at a macro fund for a mid-level PM might be $200mm AUM, 10% drawdown limit. With a book like this, it's not impossible to have years where you make $50-100mm or even more if you get lucky. Obviously, this is not the base case, but I think blowout years are more common with this type of structure.

Thank you for the insightful answer. This is why I like WSO. Just 3 follow ups if I may. 

1. When you say the tools of analysis are python/stats, can you give some examples of what you are looking at to derive trading ideas? For instance, in fundy equities, I may use excel to model out some new project of a company to see how such would affect EBITDA, cash flow/DCF, and valuation multiples. What are the analogous assessments you'd look at in regressions, PCA, econometrics for rates/fx? Just what to get a sense of how people even approach the analysis in this field and how one generates an edge (in equities, for eg. it could be about incorporating more complete fundamental information / assumptions in your company modelling that market's missed to better reflect reality)

2. Fair to say that long/short vol with options are very bread and butter play in rates/fx trading? (most long/short equities books are rather limited in option uses, so I just want to see if there are truly inherent contrasts between rates/fx and equities when it comes to options usage)


3. Lastly, how much overlap in analysis or variables are there between FX and Rates? My limited self-taught understanding with FX is that on the month-to-years timeframe, moves seems to be ultimately driven by inflation/interest rate expectations or monetary policy from the central banks. Day to day, risk aversion sentiment seems to play a part? It seems that rates move on these similar variables? If so, if you cover rates, your skills would be pretty transferable in FX; and vice versa? Just wondering if its accurate to analogize the analytical overlap between rates and fx to those between say equities and credits (equities focuses more on the upside whereas credits focus more on fixed cash flow, liquidation value and covenants, but you are still modelling the same company and essentially doing the same type of proforma projections, just stretching your scenarios differently)

Any thoughts would be appreciated again!

Most Helpful
  • Research Analyst in HF - RelVal
2mo

1. Ironically I actually got my start in IB (long story), so I'm familiar with the techniques of fundamental equities analysis. First, I would say that intuition/first principles logic is more important in rates/fx than in fundamental equities. There's nothing as ubiquitous as a DCF model to determine the "fair value" of any interest rate, exchange pair, or derivative thereof. Everything is far more subjective and comparisons are usually relative to something else as opposed to an assessment of absolute value.

For example, someone may think FRA/OIS (future expectations for LIBOR/OIS spreads, a proxy for credit/liquidity risk in dollar funding markets, mostly domestically, but some offshore) is trading cheap/rich relative to FX OIS for some currency pair, let's say USDJPY. To do this, you might run a regression on observed FRA/OIS values vs. some theoretical model's values of FRA/OIS at the current USDJPY FX OIS basis and determine whether FRA/OIS is trading rich or cheap relative to historical values. You can also do this for different parts of various interest rate curves e.g., maybe 20y USTs are trading rich/cheap relative to the value of 10s and 30s.

In this case, usually your edge is not the theoretical model of fair value that you use but having a better judgement of the expected values of where things "should" be trading at vs. where they are trading at. This comes from having a very solid framework for understanding how international capital flows function and structuring trades in a clever way. For example, understanding how Hong Kong's currency peg works, you can predict how HK rates and the HKDUSD exchange rate will react in response to the Fed raising rates. You can track this by monitoring the level of the HKMA's FX reserve buffer.

2. Fx/rates vol are definitely important to understand, even if you don't express positions with options. There's an analogous concept in interest rate markets called "carry," which refers to leveraging a fixed income position. Carry trades are analogous to being short vol (collecting a fixed payment, "carry" or "theta" in exchange for blowup risk), and vice versa - usually to be short carry is to be long vol. Because of the variety of instruments available, there are ways to be "long volatility" without explicitly buying options e.g., betting that a certain carry trade will blow up and putting on FRA/OIS steepeners. 

3. I would say that's roughly accurate. I thought about making the equities/credit comparison earlier, but refrained because I think fx/rates are more closely related than equities and credit. Fx/rates are really the expression of the same thing (capital flows) across two different dimensions, but equity and credit instruments are discrete and can be affected by different things. Things that may affect a stock price may not necessarily affect its bond price and vice versa. To get an intuition for this, you can read this primer from Credit Suisse on cross-currency basis swaps and think about how both interest rates and fx are affected by the same transaction. FWIW, most currency turnover is in the FX swaps market, not the cash market, and have interest rate exposure as well as fx exposure as you're borrowing in one currency and lending in another.

2mo
Flâneur, what's your opinion? Comment below:

I've also had similar thoughts. Over the past 6-12 months I've tried my best to get up the curve on Macro fundamentals and have found some great resources.

I'd recommend you read this and find check out @MrBlonde_macro on twitter. He does a great job of explaining his process on the blockworks podcast. 

Remember, the grass is always greener on the otherside because it's fertilized with bullshit.
  • 2
2mo
Flâneur, what's your opinion? Comment below:

Sorry, the host expired. Here is the updated link. 

https://www.dropbox.com/s/e0d07xkd4yngqeq/Lessons%20from%20Crises%2C%20clients%20and%20colleages%20JPM.pdf?dl=0

Remember, the grass is always greener on the otherside because it's fertilized with bullshit.
  • 1
2mo
Fill-or-kill, what's your opinion? Comment below:
Banks often lump Rates and FX together. Is this because both asset classes are driven by interest rates, therefore you can cover both with the related/if not the same type of fundamental analysis?

Rates are the primary driver of FX, and rates sales will have a significant foreign interest, which requires at-ready FX personnel. Also true about similar analytical approach (central bank watch, economic indicator data, etc.).

Lots of people in this field seem to have a really quantitative background. Why is this? Are you trying to get edge from your competition by performing complex stochastic/statistical/correlational analysis? Or do you need the quant skills to sift through extensive amount of economic/fundamental data (ie inflation expectations, implied pricing assumptions from swaps/derivs, yield expectations from market etc.)

As others have mentioned, you don't need to be super quant-y off the bat, but if you take risk, you'll want to be intimately familiar with how your models work, where your edge is coming from, and how to quickly pull/distribute runs.

Does it make sense that if you are good, let's say the top 10% to 20% over a period of 5 to 10 years+, FX and Rates funds are more scalable and the return generated are higher than that of fundamental equities, because even though equities have a higher inherent yield, FX and Rates are deeper markets (tolerant of scaling) and - net of leveragevolatilities (opportunity of profit) are actually higher in FX and Rates than in equities with 3-5x leverage.

Yes.

I've heard of stories of star trader bringing home 7 to 9 digits, almost always they are rates traders (or sometimes commods guys). What is it about the structure of their trading/payout that allow them such astronamical comps, while those in other assets classes can't get even close?

Rates desk flow is massive.

Just for shits and giggles, how would one transition to FX/Rates from 8 years in fundamental equities?

Start as a jr somewhere.

2mo
halfstep, what's your opinion? Comment below:
Fill-or-kill
Banks often lump Rates and FX together. Is this because both asset classes are driven by interest rates, therefore you can cover both with the related/if not the same type of fundamental analysis?

Rates are the primary driver of FX, and rates sales will have a significant foreign interest, which requires at-ready FX personnel. Also true about similar analytical approach (central bank watch, economic indicator data, etc.).

Lots of people in this field seem to have a really quantitative background. Why is this? Are you trying to get edge from your competition by performing complex stochastic/statistical/correlational analysis? Or do you need the quant skills to sift through extensive amount of economic/fundamental data (ie inflation expectations, implied pricing assumptions from swaps/derivs, yield expectations from market etc.)

As others have mentioned, you don't need to be super quant-y off the bat, but if you take risk, you'll want to be intimately familiar with how your models work, where your edge is coming from, and how to quickly pull/distribute runs.

Does it make sense that if you are good, let's say the top 10% to 20% over a period of 5 to 10 years+, FX and Rates funds are more scalable and the return generated are higher than that of fundamental equities, because even though equities have a higher inherent yield, FX and Rates are deeper markets (tolerant of scaling) and - net of leveragevolatilities (opportunity of profit) are actually higher in FX and Rates than in equities with 3-5x leverage.

Yes.

I've heard of stories of star trader bringing home 7 to 9 digits, almost always they are rates traders (or sometimes commods guys). What is it about the structure of their trading/payout that allow them such astronamical comps, while those in other assets classes can't get even close?

Rates desk flow is massive.

Just for shits and giggles, how would one transition to FX/Rates from 8 years in fundamental equities?

Start as a jr somewhere.

Thank you. This is very helpful

  • Prospect in IB - Cov
2mo

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