Dollar Funded Carry Trades Outperform Yen, Franc With Fed on Hold Longer
Aug. 5 (Bloomberg) -- Philip Manduca, head of investment at ECU Group Plc, talks about his investment strategy for currencies and gold. He speaks with Maryam Nemazee on Bloomberg Television's "The Pulse." (Source: Bloomberg)
Investors reaped bigger gains since the start of June by funding investments in higher-yielding currencies with dollar-denominated loans than similar strategies using Japanese yen- or Swiss franc-based funding.
A basket of currencies including the legal tender of Australia, Canada and New Zealand and Brazilian real financed with U.S. dollars returned 7.8 percent since the start of June, compared with 2 percent when funded in yen and a loss of 2.5 percent in Swiss francs, according to data compiled by Bloomberg.
Expectations that the Federal Reserve will keep interest rates at record lows into next year combined with traders’ speculation that policy makers may be forced to resume buying securities to help provide additional stimulus to the economy makes dollar-based funding attractive. Carry trades financed in dollars and yen lost money in the first five months of the year, while the franc-funded trades returned 8.2 percent.
“The outlook for a return to a dollar-funded carry trade is becoming compelling,” said Ray Farris, head of foreign- exchange strategy at Credit Suisse Group AG in London. “The weaker-than-expected U.S. recovery implies a Fed that is on hold, or easier, for longer. Yield spreads are likely to remain more averse to the U.S. dollar for longer.”
The gap between rates on three-month euro-denominated loans and those funded in dollars has more than quadrupled to 0.41 percentage point from 0.1 percentage point on May 27, the lowest since January 2008.
Making Revisions
In the carry trade, investors borrow in low-rate countries to buy higher-yielding assets, in expectation that gains made on the interest-rate differential won’t be offset by changes in exchange rates.
Credit Suisse’s currency strategists on July 23 revised their three-month forecast for the dollar versus the yen to 85, from 93 and to $1.3 per euro from $1.16 in part given the risk the U.S. currency will be used more to fund carry trades. In a separate note published Aug. 3, the strategists said the odds were “high” that the dollar-yen exchange rate could move below their three-month forecast.
The yen touched an eight-month high yesterday against the dollar on speculation growth in the world’s biggest economy is slowing and the Fed may signal additional stimulus measures at next week’s policy meeting.
The yen strengthened to 85.33 per dollar yesterday, its highest level since Nov. 27, when the yen touched levels last seen in 1995. The Japanese currency rose 0.1 percent to 86.21 at 8:15 a.m. in New York.
‘Greater Dilemma’
“The Fed’s greater dilemma -- the uncertainty surrounding the strength of the U.S. recovery -- I believe, is a lingering effect of the U.S.-centered crisis,” said Naomi Fink, a Tokyo- based strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. “I was always of the opinion that Fed hikes were unlikely to be around the corner. The U.S. yield curve is already steeper than many of its counterparts, so the intra-curve carry has been there for a while already.”
The Fed has kept its benchmark rate at zero to 0.25 percent since December 2008, while the European Central Bank’s main rate has been at a record low of 1 percent since May 2009. The Australian central bank’s benchmark interest rate is 4.5 percent.
Credit Suisse economists pushed back their forecast for the timing of the first Fed rate increase last month to 2012 from the first quarter of 2011.
To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net
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