[AndrewWoo]

In various quarters, both USD and GBP are being described as “the new yen” or the world’s funding currency of choice. But are they? Are USD and GBP falling because they now have the status of funding currency or are they being branded
funding currencies because they are falling? It is not entirely clear whether funding currency status reflects a causal relationship or post justification for past exchange rate weakness. After all, with a majority of six G10 countries now pursuing near-zero interest rate polices, there are plenty of other currencies competing for the role of “the new yen”.

So what defines a funding currency?

A low interest rate is the obvious defining feature of a funding currency, but beyond that, the appropriateness of funding in the various low yielders depends critically on what is being funded – i.e. the long position on the other side of the
funding currency short. In an ideal world, and motivated by carry alone, a long high yield position would be best funded in a currency that, other than interest rates, has similar characteristics to the high yielder itself. In other words, an
investor taking a long AUD position would ideally like to short a currency that moves up and down in parallel with AUD, reducing the volatility of the cross and hence minimising the risk of the spot position being stopped.

Several points are worth highlighting
• Selling USD or GBP is not the most efficient way of funding a long position in any of the main high yield currencies, though GBP does come a close second or third
in some cases; BRL for example. This suggests funding currency status has more to do with post rationalisation of previous weakness than reality.

• CAD and SEK are consistently highlighted as good funding currencies. Both have the attractive attributes of being low yielding risky assets, so they tend to sell off
along with, for example, AUD and NZD. In CAD’s case, rising BoC rate expectations will likely diminish its attractiveness going forward, but SEK looks highly vulnerable if appetite for yield continues to rise.

• As expected, the fall in rates to Japanese levels in many other G10 countries leaves JPY looking highly unattractive as a funding currency for any of the main high yield markets. The search for a “new yen” is a legitimate one and this adds further weight to the fundamentally bullish-JPY view.