JPMorgan’s enhanced notes tied to dollar versus yen show tactical bullish bet on U.S. currency

By Emma Trincal

New York, Feb. 21 – JPMorgan Chase Financial Co. LLC’s 0% capped enhanced participation currency-linked notes due March 26, 2019 linked to the U.S. dollar/Japanese yen exchange rate offer a bullish bet on the dollar versus the yen. As the dollar recently dropped after rallying last year, the trade may make tactical sense. But sources were focused on unpredictable factors such as the return of inflation in the U.S. and the monetary policy of the central banks.

The currency return will be positive if the dollar strengthens relative to the yen, according to a 424B2 filing with the Securities and Exchange Commission.

If the currency return is positive, the payout at maturity will be par plus 2.35 to 2.58 times the currency return, up to a maximum settlement amount of $3,350 to $3,580 per $1,000 note.

If the currency return is zero or negative, the payout will be par plus the currency return, subject to minimum payment of zero. If the final exchange rate is less than or equal to 50% of the strike rate, investors will lose their entire investment.

Investors buying the notes expect that the U.S. dollar will appreciate against the Japanese yen at the end of the 13-month term. This outcome is the same as betting on a positive currency return: it will take more Japanese yen to purchase one U.S. dollar at maturity, explains the prospectus.

Solid structure

A currency structurer said the terms of the notes are fairly attractive.

“Your full principal is at risk but the 50% protection looks good,” he said.

“Unless you fall beyond that, the worst-case scenario is that you get nothing.

“I don’t think a 50% drop has ever happened. I think it’s very unlikely.

“On the upside, the leverage and the cap are pretty good too.”

The terms are appealing as a result of the recent drop in the dollar while the yen rose sharply since the beginning of the year, he explained.

“The forward is downward slopping right now. From the market perspective, the forward suggests that the dollar a year from now will depreciate by another 3% versus the yen from current levels.”

There are a lot of reasons behind the decline in the dollar, most of which are technical, he said.

“The dollar had rallied so much. A big part of the sell-off was profit-taking,” he said.

Since late last week, however, the greenback has regained some strength, showing signs of a reversal.

Inflation fears

Yet the structurer said he was not sure whether making a bullish bet on the U.S. dollar was timely.

“It’s the USD versus the yen, and the yen has strengthened a lot. If you think in terms of the U.S. recovery and the rate differentials between the two countries, it makes the dollar more attractive.

“But that’s not what people are looking at right now.”

He explained that U.S. interest rates have been up while the dollar has declined, which is unusual. More commonly higher rates tend to attract buyers of the currency, which causes the currency to appreciate.

This correlation has lately not been observed. He explained why.

“People are very concerned about inflation right now. That’s why the dollar has been down,” he said.

“Remember how the equity sell-off started...just after the job report showing a big increase in wage growth.

“The dollar started to drop at that point.”

Aside from inflation, which could directly impact the exchange rate and push down the value of the U.S. dollar, the fundamentals of the trade are still interesting, this structurer said.

“I can’t tell if the dollar is going to rally against the yen in the next 13 months. I don’t know if the timing is right. But the fundamentals of the U.S. economy look good. There is no fundamental reason for the dollar to depreciate,” he said.

Bank of Japan

Jason Barsema, co-founder and president of Halo Investing, Inc., pointed to another factor of uncertainty: the role of central banks. Both the Bank of Japan and the Federal Reserve can manipulate interest rates and therefore cause unexpected swings in exchange rates.

“It’s a tactical play and I usually don’t do those deals. But I find it easier on the dollar side to be bullish. With the yen it’s more difficult,” he said.

So far, the dollar is still “overvalued” while the yen is “very strong,” he noted.

“The BOJ is still in liquidity/easing mode. People are long the yen and short the dollar because the yen is a cheap currency to borrow.

“What the BOJ is going to do is hard to predict. I would be more comfortable betting on the dollar versus the euro or dollar versus pound.

“Japan is a tough call. It will depend a lot on what the central bank will do there.

“If you’re modestly bullish on the dollar, this trade makes sense. There’s room for more dollar appreciation.

“But the yen can certainly be stronger, and I would be nervous about the BOJ.

“Don’t fight central banks....don’t fight the BOJ!”

FX out of fashion

Currency-linked notes have become very rare in the U.S. structured notes market.

Only two such deals have priced so far this year, both brought to market by the same issuer.

On Feb. 2 JPMorgan Chase Financial Co. LLC priced $4.65 million of notes linked to the euro/U.S. dollar exchange rate.

Earlier during that week, the issuer sold $1.7 million of notes linked to the performance of the U.S. dollar relative to an equally weighted basket of three currencies. Those were the euro, the British pound and the Japanese yen.

J.P. Morgan Securities LLC is the agent for the deal, which will settle on Feb. 28.

The notes will be guaranteed by JPMorgan Chase & Co.

The Cusip number is 46647MQR7.

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