Deutsche Bank’s digital notes tied to rupee vs. euro point to euro’s new role in carry trade

By Emma Trincal

New York, Feb. 27 – Deutsche Bank AG, London Branch’s planned digital return notes due March 16, 2016 linked to the performance of the Indian rupee versus the euro will make for a rare use of this currency pair in a structured note, an FX market participant said.

“I don’t come across that currency pair very often. It’s very weird,” said Win Thin, senior currency strategist at Brown Brothers Harriman & Co.

Others said that the declining euro combined with a renewed bullish sentiment around India after a change of government last year set the stage for a new type of carry trade, with investors selling the European currency in order to buy the Indian rupee. The structured note reflects this particular trade.

The currency performance will be positive if the rupee strengthens relative to the euro, according to an FWP filing with the Securities and Exchange Commission.

If the currency performance is greater than or equal to zero, the payout at maturity will be par plus 11.4%. If the currency performance is less than zero but greater than or equal to negative 10%, the payout will be par. If the currency performance is less than negative 10%, investors will lose 1% of par for every 1% that the currency performance is negative.

The spot rate is the number of rupees per euro, or EUR/INR. As a result, a decrease in the spot rate means that the rupee has strengthened relative to the euro.

Volatile play

“If the rupee appreciates only a tiny little bit against the euro, I get 11.4%. That’s good news,” said Thin.

“But the 10% protection, I don’t like that. Currencies can move easily 10% in one year, especially with emerging market currencies. The protection is not that great.”

He pointed to the volatility for this currency pair.

“The EUR/INR realized volatility for three months is at a record high at 13%,” he noted.

“In comparison, the realized vol for USD/INR is only 6.5%, almost double. You’re adding an extra layer of volatility. That’s very high risk.”

The rupee last year outperformed the dollar until May, at which point the trend reversed.

“Even though the rupee has weakened against the dollar since May, the euro has weakened even more. So there is room for arbitrage here,” he said.

“But adding the euro adds complexity to the situation as the emerging markets currencies are still in flux.

“The product doesn’t give me much comfort. As the Indian rupee has already appreciated quite a lot against the euro, you may wonder if the rally still has legs. I’m not sure, honestly.”

The main issue is the risk-reward premium.

“With this product, you can be bullish on India and bearish on the euro. There’s more potential bang for your buck. But you’re picking a more volatile currency pair, and I don’t think you’re being compensated enough for that.”

The weak euro

Market participants in the FX structured products market said that while not so long ago, bullish bets on emerging market currencies were structured against the dollar, they are now seeing the euro playing the role of the “weak currency” as the new funding currency for the carry trade.

“I’m seeing a lot of those trades – emerging markets versus the euro. It’s more of a fundamental play than anything else. Europe has started QE in January. The market expects further depreciation of the euro against other currencies,” a currency notes structurer said.

“You used to see those pair trades with the dollar when the dollar itself was weak. That’s when the U.S. was doing its own QE. Now this is behind us and the dollar is no longer a weak currency. I think you’ll see more and more notes based on emerging market currencies versus the euro than before.”

He said he came across several notes tied to the Mexican peso versus the euro, adding that he was not surprised to see the rupee joining the trend.

India rising

In prior offerings, the rupee was often part of a basket of emerging market currencies rather than the sole underlying currency, according to data compiled by Prospect News.

But the economic situation in India has improved since May with the election of a new prime minister, Narendra Modi, said the structurer.

“This note is not just a currency deal. It’s a macroeconomic play on an emerging market that has been doing well. India has a new government. Its economy is stable, even bullish,” he said.

The iShares India 50 exchange-traded fund is up 11% year to date.

“So betting on the appreciation of the Indian rupee versus the euro makes a lot of sense.”

JPMorgan trades

In July, Goldman Sachs Group, Inc. priced the last rupee-versus-euro deal in a $675,000 offering of one-year notes.

JPMorgan was the placement agent.

Earlier in April, JPMorgan Chase & Co. priced $24.08 million of 0% quarterly review notes. The underlying was the rupee, but the reference currency was the dollar.

JPMorgan is also the placement agent for the Deutsche Bank digital deal.

“JPMorgan has a view. They’re promoting their view,” said the structurer.

“The 10% protection is OK. It’s more of a fundamental view. The one-year realized volatility is at around 15%. It’s definitely high. But you enjoy a nice upside.

“The volatility is much higher than with a G10 currency pair but lower than equities. It’s a different asset class. I think 10% is fine.”

JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the agents.

The notes are expected to settle Wednesday.

The Cusip number is 2515A1MG3.

© 2015 Prospect News.
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