Cross-border bids will affect the FX markets

DRAGONS and tigers are known for their voracious appetites. China and India, it appears, are no exception – these Asian powerhouses’ demand for raw materials has proved unrelenting despite the subdued global backdrop.

The outlook for sustained commodities’ demand has spurred the natural resources sector into action. Mergers and acquisitions (M&A) activity has stepped up a gear with companies such as miners, oil and gas producers and fertiliser makers launching $316bn in deals so far this year, according to data provider Dealogic.

While M&A activity has brought the natural resources sector into the limelight, foreign exchange traders should also be taking note. Recent high-profile announcements – such as BHP Billiton’s hostile bid for PotashCorp – have raised expectations of a pick-up in cross-border M&A. If this is the case, then the FX markets would also be affected, says ING’s Tom Levinson.

He argues that periods of rising M&A typically see companies in high growth economies targeted. Together with a desire from emerging markets to secure strategic, long-term access to commodities, Levinson says both the Canadian dollar and the Australian dollar are well positioned – since many resources companies are located in either Canada or Australia.

Consequently, FX traders might look to go long on both the Loonie and the Aussie, both of which have suffered in recent weeks from increased risk aversion and, in the case of Australia, the political turmoil. Indeed, the recent M&A news boosted the Canadian dollar and the general portfolio and FDI flows are also extremely positive, say currency strategists at BNP Paribas.

But while both the Loonie and the Aussie appear the best placed to gain from a surge in cross-border M&A, to what extent are their currencies likely to benefit? Research conducted by Francis Breedon and Francesca Fornasari at Lehman Brothers in 2000 revealed that M&A deals cause, on average, a 1 per cent appreciation of the target nation currency relative to that of the acquirer. In contrast, the acquiring currency experiences a move of equal size but in the opposite direction. Breedon and Fornasari also found that every extra $1bn in deal size has a 0.5 per cent positive impact on the target nation’s currency.

For example, when British insurer Prudential announced in March that it was going to acquire AIA part-funded by $25bn in cash, sterling dropped sharply. In early June, when the Pru pulled out of the deal, sterling got a short-term boost.

Overall, the Loonie is likely to see more upside as a result of cross-border M&A than the Aussie dollar simply because it does not have the political uncertainty capping its strength. But FX traders should look to capitalise on any boost to either currency from takeover activity.