Barclays synthetic notes linked to Australian dollar to be used for hedge against weak dollar

By Emma Trincal

New York, Jan. 4 - Barclays Bank plc's planned synthetic foreign currency note linked to the Australian dollar is appealing to investors who continue to be bearish on the U.S. dollar, given the strength of the Australian economy, sources said.

But those sources also warn that the timing of this investment may not be best: The market is now turning more bullish on the U.S. dollar ahead of a well-anticipated tightening move from the Federal Reserve Board.

Barclays plans to price synthetic foreign currency notes due Jan. 29, 2013 linked to the Australian dollar-U.S. dollar exchange rate, according to an FWP filing with the Securities and Exchange Commission.

Interest will be payable semiannually and will accrue at a floating rate calculated using the to-be-determined interest rate of 5% to 5.5% multiplied by the Australian dollar notional amount times the spot rate times the day count fraction.

If the Australian dollar becomes worthless relative to the U.S. dollar, the interest payment will fall to zero.

The payout at maturity will be par plus the performance of the spot rate. Investors will share in any losses.

The notes can be used as a bet against the U.S. dollar or as a hedge to protect a portfolio against a continued weakening of the U.S. dollar against the Australian currency, according to the filing documents.

Fed wildcard

Meg Browne, senior currency strategist at Brown Brothers Harriman & Co., has a macroeconomic view that goes against the rationale of the Barclays notes but only for a one-year horizon as her forecast is for 2010 only.

Browne said that the recent U.S. dollar rally seen in November and December suggests that many investors are regaining confidence in the U.S. currency as they see signs that the U.S. economy is recovering, which will prompt the Fed to raise rates this year.

"The dollar will strengthen against foreign currencies, including the Australian dollar over the course of 2010," she said.

She predicated that the Australian dollar-U.S. dollar spot rate, currently at 0.91 U.S. dollars per Australian dollar, will decrease to 0.79 by year-end.

"The big picture is that people have been purchasing foreign currencies and selling dollars because the U.S. has such low interest rates," Browne said. "The paradox was that the positive global economic news, as well as positive U.S. economic news, did not help the dollar. At the contrary, people have been more willing to take risk and they have invested in foreign markets, causing the U.S. dollar to weaken."

But Browne sees this weak U.S. dollar trend reversing this year due to the highly anticipated Fed intervention.

"As the U.S. economy regains strength, the Fed will hike rates this year, probably starting mid-year. As the Fed is likely to shift its policy and as the market begins to price higher U.S. interest rates, the weak dollar trend will revert back in favor to the U.S. dollar," Browne said.

Browne predicted that the positive impact of the Fed hikes on the U.S. dollar will probably continue after this year, because "it won't stop after one hike."

"However, after one year, anything could happen," she said.

Australia is strong

Other sources said that the choice of the Australian currency was a sound one for investors bearish on the U.S. dollar but stressed that the three-year investment horizon made it difficult to have a view on the notes.

While being bullish on the Australian currency makes sense given the strength of the Australian economy and the tendency of the central bank to raise rates, the Fed's upcoming shift in monetary policy adds risk to this picture, those sources said.

Matt Lloyd, chief investment strategist at Advisors Asset Management, said, "The Australian dollar is one of those foreign currencies that should continue to do well against the dollar given the fact that you have interest rates rising there." He predicted that the Australian currency should rally against the U.S. dollar for a year but that the Australian dollar and the U.S. dollar should be trading in range for the next year or two.

"As the Fed becomes more aggressive, [the Fed hikes] will start to counteract the moves by the Australian central bank," Lloyd said.

However, the nature of the Fed action, which Lloyd said will be mild, should somewhat offset the positive impact of the Fed on the U.S. dollar.

"The Fed is likely to raise rates in an accommodative manner because they don't want to take the risk of a double-dip recession," he said.

"It's hard to say if this investment makes sense over a three-year period."

60% chances

A currency strategist at a bank in New York, which is not involved in the deal, agreed that the three-year term makes it difficult to have a view. But based on his own model, he said, "Investors in a note betting on the appreciation of the Australian dollar against the U.S. dollar have 60% chances to be right. It seems reasonable because investing in Australia is a bet on commodities. It also gives you exposure to Asia. And finally Australia has a pretty strong economy."

For this strategist, the Fed may not be a determining factor.

"While the Fed tightening represents a short-term risk, it's not necessarily a negative as long as the Australian central bank is more aggressive than the U.S.," the strategist noted. He said that the Australian central bank could very well end up raising its rates more aggressively than the Fed because "Australia should be doing quite well" and also because "if the Fed is in tightening mode, it will be a positive event globally."

UBS Financial Services Inc. and Barclays Capital Inc. are the underwriters.

The notes are expected to price on Jan. 26 and settle on Jan. 29.

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