Dollar Divergence Trade Becomes So Alluring Nurses Bet Pensions

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Ontario’s hospital workers have never played much in the foreign-exchange market. That’s about to change, thanks to Janet Yellen.

The growing chasm between Yellen’s Federal Reserve -- which is forecast to raise interest rates this year -- and central banks in Europe and Japan that are committed to their easy-money policies spells opportunity to the Healthcare of Ontario Pension Plan, which manages C$61 billion ($49 billion) for almost 300,000 doctors, nurses and other health-care workers in the Canadian province.

“We haven’t been a big player in foreign exchange, but there’s some pricing anomalies we’re seeing out there because of these extreme differences in interest rates between countries,” said Jim Keohane, Healthcare of Ontario’s chief executive in Toronto. “So we’re trying to figure out ways to arbitrage that.”

While economic-policy divergence isn’t new, efforts to profit from it over the first half of the year have been swamped by violent price swings resulting from the Greek debt saga and global flip-flopping on policy. Mixed U.S. economic data also had the market pushing back forecasts for a Fed rate increase. Now, analysts say a clear two-speed growth model is emerging.

‘Both Angles’

“The Fed is tightening and other central banks in the main are basically easing,” said Alan Ruskin, global head of Group of 10 foreign-exchange strategy in New York at Deutsche Bank AG. “This is working from both angles.”

Healthcare of Ontario’s strategy is to bet on declines in low-yielding currency futures and invest to seek gains in higher yielders, Keohane said. The fund, which has averaged 10 percent returns during the past decade, will consider all currency pairs while concentrating in developed nations with active long-term forward and options markets, spokesman Joe Vecsi wrote in an e-mail. He said trades may benefit from increased volatility.

Price swings, or volatility, can be the enemy of investors playing rate differentials, because one big price move can erase returns. And this year, unexpected shocks -- from the Swiss National Bank’s surprise scrapping of its franc cap in January to the brinkmanship over Greece’s place in the euro bloc -- have helped drive the Deutsche Bank G10 FX Carry Basket Spot Index to its lowest closing level since 2009.

High Yielders

Almost all the carry trades that involved borrowing in the U.S. dollar to invest in other major currencies, and more than half those funded in yen, lost money in the first half of the year, according to Bloomberg calculations. Some of the most popular high-yielding currencies in which to invest, including New Zealand’s kiwi and the Brazilian real, have lost the most -- even when investors were using the tanking euro to fund their trades.

While the divergence trade derailed after a weather-related economic slowdown cast doubt on the timing of a Fed rate increase, the U.S. economy has firmed enough for the strategy to make money for years to come, Deutsche Bank’s Ruskin said.

Futures show a 34 percent chance the Fed will raise its benchmark rate in September and a 73 percent chance of an increase by December, according to data compiled by Bloomberg.

The U.S. dollar will strengthen 5.2 percent to $1.05 per euro by the middle of next year, according to the median estimate in a Bloomberg survey. The New Zealand and Canadian dollars -- boasting among the highest interest rates in the developed world -- are projected to gain about 5 percent versus the euro.

While Fed rate increases may initially fuel volatility, once things start to settle down, conditions for the divergence investing will improve, said Steven Englander, global head of Group of 10 currency strategy at Citigroup Inc.

“You wait until the market has absorbed the fact the Fed is tightening,” he said by phone from New York. “Once that’s priced in, you say the risk of spot move has diminished, whereas you’re still clipping a fat coupon. So you go into the real high-yielders.”

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