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Carry Trade Rallies Like ’09 as Volatility Ebbs Amid Threats

Carry Trade Rallies Like ’09 as Volatility Ebbs Amid Threats
Borrowing in dollars or yen to buy high-yielding Brazilian reais and Mexican pesos has returned 5.5 percent this year, the best start on record, and reversing last year’s 15 percent loss, the UBS AG V24 Carry Index shows. Photographer: Chris Ratcliffe/Bloomberg

In the $4 trillion-a-day currency market, traders calmed by a flood of central bank money are leaving safety for riskier bets against a background of Greece’s potential default and threats of nuclear weapons in Iran.

Borrowing in dollars or yen to buy high-yielding Brazilian reais and Mexican pesos has returned 5.5 percent this year, the best start on record, and reversing last year’s 15 percent loss, the UBS AG V24 Carry Index shows. Market volatility dropped last week to the lowest since August 2008, as measured by a JPMorgan Chase & Co. index.

Increasing trades that depend on stability underscores growing confidence that the global economy and financial system will withstand shocks as central bankers blanket the world with cash. It’s also proving a challenge for emerging markets such as Brazil, where policy makers renewed purchases of dollars to keep the real from strengthening too fast and damaging growth.

“There’s less nervousness in the market in general,” Jose Wynne, the head of North America foreign-exchange research at the investment banking unit of Barclays Plc, said in a Feb. 7 telephone interview. “Now that the central banks are pumping on one side of the system, you have people jumping on carry trades everywhere.”

The currencies of New Zealand, Mexico, Brazil, Indonesia and South Africa are poised to rally this year against the greenback, euro, pound and yen, Wynne said. All those countries have benchmark interest rates between 2.5 percent and 10.5 percent, higher than rates of zero to 1 percent in the U.S., Europe, Japan and the U.K.

Similar to 2009

The dollar weakened 0.3 percent last week to $1.3197 per euro, and strengthened 1.3 percent against Japan’s currency to 77.61 yen.

Current market conditions remind traders of 2009, another period when demand for riskier assets soared as governments around the world added stimulus and central banks cut rates in an effort to prop up an economy reeling from the worst financial crisis since World War II.

The Standard & Poor’s 500 Index rose 23 percent then and the S&P GSCI Total Return Index of raw materials added 13 percent. The UBS V24 Carry Index rose 13.9 percent, its best performance since 2005, before falling 2.5 percent in 2010 and 15 percent in 2011.

‘Largely Unanticipated’

Brazil’s real rallied 33 percent in 2009 for its best performance against the dollar, followed by the South African rand’s 29 percent gain.

“During 2009, you had a pickup in risk appetite and risky assets rallied, and it also came about unexpectedly,” Michael Woolfolk, senior currency strategist in New York at Bank of New York Mellon Corp., the world’s largest custodial bank, said in a Feb. 3 telephone interview. “This rally we saw in January was also largely unanticipated.”

The UBS index jumped 4.7 percent in January to 449.56, and climbed to as high as 456.14 on Feb. 3 before easing to 452.89 last week.

Mexico’s peso has appreciated 9.7 percent this year against the dollar, leading gains among 16 major currencies tracked by Bloomberg. The real has posted an 8.4 percent advance and New Zealand’s dollar has rallied 7.5 percent.

Higher-yielding currencies have strengthened even as tensions rise in the Middle East and the sovereign-debt crisis in Europe continues.

Iran, Europe

Iranian officials have warned they may shut the Strait of Hormuz, which allows passage of a fifth of the world’s oil, in response to sanctions imposed by the European Union and the U.S. to keep the nation from developing nuclear weapons.

European leaders have struggled to reach agreements on the next bailout package for Greece and on rules for a tighter fiscal union for all EU member nations.

The crisis has led Greece, Portugal, Ireland, Italy and France to implement austerity measures in an effort to cut budget deficits, steps that will subtract about 1.3 percentage points from growth in the region this year, JPMorgan Chase economists estimate.

Greek Prime Minister Lucas Papademos won parliamentary approval for measures to reduce spending needed to secure aid, while rioters protesting the measures battled police and set fire to buildings in downtown Athens. A total of 199 lawmakers voted in favor and 74 against, Parliament Speaker Filippos Petsalnikos said in remarks carried live on state-run Vouli TV.

Investors are putting their faith in policy makers who are driving down interest rates and flooding the world with cash to prop up their economies. The balance sheets of the world’s six biggest central banks have more than doubled since 2006 to $13.2 trillion, according to Chicago-based Bianco Research LLC.

‘Nothing More Powerful’

“If you think of asset markets, there’s nothing more powerful than a central bank that’s not raising rates even as economic data is improving,” Steven Englander, head of Group of 10 currency strategy at Citigroup in New York, said in a Feb. 8 telephone interview. “Stronger growth, combined with the liquidity provisions that most of the major central banks are committed to, is making investors much more comfortable with risk.”

Policy makers in nations that have seen their currencies strengthen are starting to take action, threatening returns from the carry trade.

Brazil Intervention

Brazil resumed intervention as the real reached a three-month high of 1.7126 per dollar last week. The nation’s central bank bought dollars in the foreign-exchange market twice this month, its first purchases since July, to slow the rally that policy makers say may weigh on exports and undermine the economy’s rebound.

Australia’s dollar weakened from a six-month high last week as the Reserve Bank lowered its forecast for growth this year. The central bank said it sees the economy expanding 3.5 percent in 2012, down from a Nov. 4 estimate of 4 percent.

Investors have piled into the riskier assets as volatility in the foreign-exchange market subsided, cutting the risk that currency moves will erase profits in the carry trade.

The MSCI World Index of equities has added 7.6 percent this year as the VIX -- a measure of equity volatility known as the fear index -- fell to 17.1 on Feb. 3, the lowest since July, according to the Chicago Board Options Exchange. In commodities, the S&P GSCI Total Return Index has climbed 4.6 percent.

Implied volatility of three-month options on currencies dropped to 9.94 percent Feb. 10, the lowest since August 2008, according to the JPMorgan Global FX Volatility Index. The measure has fallen below the average of 11.93 for 2011.

“The abundant liquidity that has been injected into all these markets tends to smooth out some of the volatility,” Robert Sinche, global head of currency strategy at Royal Bank of Scotland Plc in Stamford, Connecticut, said in a Feb. 8 telephone interview. “There are signs that global economies are stabilizing and there’s less volatility in expectations about growth in markets.”

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