Carry Trades Lose Most in Year as Slow Growth Boosts Dollar

Traders At Work
Traders are betting that falling commodities, declining stocks, sluggish U.S. growth and Europe’s sovereign-debt crisis will diminish the appeal of currencies that benefited earlier this year from higher interest rates. Photographer: Tim Boyle/Bloomberg

Slowing economic growth around the world is punishing investors who bet on Australian and Brazilian assets using money borrowed in dollars and yen with the biggest losses in more than a year.

A UBS AG index tracking the performance of carry trades where investors sell currencies with low interest rates to buy ones in 24 markets with higher yields has tumbled 2.6 percent this month after losing 2.2 percent in August and 3.1 percent in July, the biggest back-to-back monthly drop since May and June 2010. The dollar has appreciated 6.5 percent against a basket of nine developed-nation peers from its low this year on Aug. 1, with the yen up more than 7.3 percent from the same day, according to Bloomberg Correlation-Weighted Currency Indexes.

Traders are betting that falling commodities, declining stocks, sluggish U.S. growth and Europe’s sovereign-debt crisis will diminish the appeal of currencies that benefited earlier this year from higher interest rates. The Federal Reserve’s target rate of zero to 0.25 percent and the Bank of Japan’s zero to 0.1 percent overnight lending rate compare with Norway’s 2.25 percent, Australia’s 4.75 percent and Brazil’s 12 percent.

“Risk aversion is a main driving force in the market,” Ian Stannard, London-based head of European currency strategy at Morgan Stanley, said in a telephone interview on Sept. 6. “The yen and the dollar are likely to benefit from this demand.”

Losing Bets

Carry trades gained 2.1 percent from the end of January through April on optimism the economic recovery was gathering strength. Australia’s dollar and Norway’s krone soared 10 percent against the greenback in the period, and Brazil’s real rose 5.8 percent. They appreciated at least 4.7 percent versus the yen.

The bets are now losing as growth sputters, with investors seeking safety in the dollar, the world’s reserve currency, and yen. Japan’s current-account surplus means the nation doesn’t depend on foreign lenders to finance its budget deficits.

U.S. payrolls were unchanged last month, the Labor Department in Washington said Sept. 2. Germany’s economy, Europe’s biggest, grew 0.1 percent last quarter from 1.3 percent in the first three months of the year, the Federal Statistics Office in Wiesbaden said Aug. 16. The Organization for Economic Cooperation and Development said Sept. 8 the expansion for the Group of Seven nations will “stay weak” in the second half.

Gains Reverse

Investing the proceeds of yen loans in Australian dollars lost 4.2 percent in July and August, after a 1.8 percent gain in the second quarter, according to data compiled by Bloomberg. Buying Canadian securities with currency borrowed in U.S. dollars resulted in a 1.3 percent loss, after a 1 percent gain in the three months through June.

After rising to a 2011 high of 509.89 in April, the UBS V24 Carry Index dropped to 453.36 on Sept. 9, the lowest since March 2009, when the Japanese economy was mired in a recession and the Fed began buying Treasuries in an initial round of so-called quantitative easing to stimulate growth.

The dollar rose 1.7 percent last week against the so-called Aussie and reached $1.0286 per Australian dollar today, the strongest since Aug. 12. It bought 5.5465 Norwegian kroner last week, up from 5.3970 on Sept. 2, and climbed 2 percent against Brazil’s real. The yen jumped 2.1 percent versus the South African rand and was 2.1 percent stronger at 63.794 to the New Zealand dollar.

Dollar Gains

The dollar and the yen rose against most major currencies today. The greenback climbed 4 percent against the euro last week and reached $1.3495 against the shared currency today, the strongest since Feb. 16. The euro tumbled to 103.90 yen, the least since June 2001, before trading at 104.90 as of 1:30 p.m. in New York.

The dollar posted its biggest two-day gain in four months against the euro on Sept. 8 and 9 after European Central Bank President Jean-Claude Trichet said “downside risks” to the region’s economy have intensified. The comments spurred speculation the central bank will lower rates after boosting them two times this year, to 1.5 percent.

Traders also pushed the 17-nation currency lower versus the dollar as credit-default swaps signaled a more than 90 percent probability that Greece will fail to meet its debt commitments, and Juergen Stark’s resignation from the ECB’s executive board exposed the policy divisions aggravating the region’s sovereign-debt crisis.

Price Swings

Wider price swings are also hurting the carry trade because they make trading strategies less predictable. The JPMorgan Chase & Co. implied volatility index for the global currency market rose to 14 today from 10 on July 7. The index is up 36 percent this quarter, the most since it jumped 48 percent in the final three months of 2008, the year Lehman Brothers Holdings Inc. collapsed.

“It’s starting to look like the dollar is going to benefit from all this,” Stephen Jen, managing partner at SLJ Macro Partners LLP in London, said in a telephone interview on Sept. 6. “Investors’ favorites such as the Aussie dollar and the Brazilian real are suffering. The more risk-averse we become, the more supported the dollar will be,” said Jen, a former managing director at hedge fund BlueGold Capital Management LLP and at Morgan Stanley.

Too Pessimistic

Gains in the dollar and yen may evaporate should investors’ expectations for a U.S. recession prove too pessimistic, according to John Normand, global head of currency strategy at JPMorgan. Even though the recovery is losing momentum, economists don’t forecast that U.S. gross domestic product will shrink after the Fed pledged to keep interest rates at about zero through mid-2013.

After weaker than forecast growth of 0.4 percent in the first quarter and 1 percent in the second, the U.S. will probably expand 1.6 percent this year and 2.2 percent in 2012, according to Bloomberg surveys of economists. Analysts predicted 3.2 percent and 3.3 percent in Bloomberg surveys in February.

“If a recession fails to grip, dollar weakness will resume quickly and broadly,” London-based Normand said on Sept. 9. “While stagnation looks assured, recession isn’t.”

Global stocks are signaling a slowdown. The MSCI World Index fell 15 percent since June 30, after a 4 percent gain in the first half. IntercontinentalExchange Inc.’s U.S. Dollar Index, which measures the currency against the euro, yen, pound, Swiss franc, Canada dollar and Swedish krona, has climbed 4.5 percent since then, after sliding 5.8 percent in the first half.

Norway Rates

Norway’s central bank left its benchmark deposit rate unchanged on Aug. 10, when most economists surveyed by Bloomberg had expected an increase to 2.5 percent. A Credit Suisse Group AG index based on swaps signaled a 100 percent chance Australia’s central bank will cut rates by at least 25 basis points at its Oct. 4 meeting after leaving them unchanged on Sept. 6.

“Over the next three months, we should see a gradual dollar recovery,” Ken Dickson, investment director of currencies at Standard Life Investments in Edinburgh, which manages the equivalent of $251 billion, said in a telephone interview on Sept. 6. The Australian dollar is “still vulnerable to further weakness,” he said.