- Carry trade leads while valuation and momentum also rally
- Still-cheap yen helps trades along with Aussie, kiwi yields
Everyone’s a winner in the $5.3 trillion-a-day global currency market this year.
For just the second time in the past decade, three major foreign-exchange trading strategies are all producing positive returns. The carry trade, in which investors borrow in Group of 10 currencies with low interest rates and use the proceeds to buy assets with higher yields, is on pace for its biggest annual gain since 2012, according to Deutsche Bank AG index data. Trades that buy undervalued currencies and sell expensive ones, and tactics that latch onto foreign-exchange trends, are also making money.
Choosing the correct foreign-exchange strategy has become even more important in a world of unprecedented central-bank monetary stimulus and currencies linked to historically low interest rates. Investors were recalculating their approaches on Aug. 26 after Federal Reserve Chair Janet Yellen’s Jackson Hole, Wyoming speech boosted the likelihood for higher U.S. rates while monetary policy makers in Europe and Asia add stimulus.
"Central-bank policy is always going to be the number-one driver of our strategy," said James Ong, an Atlanta-based senior macro strategist at Invesco, which manages $812 billion. "The ability to acknowledge the valuation and policy dynamics in Japan was the number-one thing that helped us. Diversifying some of our trades away from being dollar trades also helped as well."
While emerging-market-based carry trades stumbled this month, the Deutsche Bank measure, which focuses on more widely traded G-10 currencies, has returned 5.8 percent this year, a stark reversal from last year’s 7.7 percent decline.
Global investors have piled into the Australian and New Zealand dollars, lured by yields that even near record lows still pay a premium over bonds from Japan, Europe and the U.S. Their rallies, a boon for carry-trade investors, fly in the face of Antipodean central bankers who continue to cut rates in an effort to boost inflation.
"Aussie and Kiwi have been moving, despite central banks saying more cuts may be in the pipeline," said Ugo Lancioni, a money manager in London at Neuberger Berman Group LLC. The firm has about $246 billion in assets under management. “Capital appreciation has allowed the strategy to perform well."
The valuation strategy is up 5.1 percent in 2016, on pace for its fourth-straight year of gains, according to Deutsche Bank data. The yen, more than 14 percent undervalued versus the Organisation for Economic Cooperation and Development’s purchasing-power-parity exchange rate to start the year, has surged almost 18 percent in 2016, defying forecasts for weakness even amid renewed monetary stimulus by the Bank of Japan.
The yen, and the valuation trade, still have room to rally, according to Viraj Patel, a foreign-exchange strategist at ING Groep NV in London.
"The yen has been the trade of the year," said Patel, who forecasts the currency to end the year at 95 per dollar. "We can’t really see the Bank of Japan’s policy assessments leading to any conclusion that would see them expanding monetary policy aggressively."
Even the momentum trade is no slouch with a 3 percent gain this year. Traders utilizing the tactic often apply models that analyze historical patterns, such as moving averages and levels of support and resistance, for clues to whether a trade has run out of steam or has more room to go.
Investors who sold the British pound during the 12 months before the U.K.’s vote to leave the European Union profited when the currency plunged as much as 13 percent in the days after Brexit.
Momentum “for us it’s been one of the best-performing strategies," said Javier Corominas, a Windsor, U.K.-based money manager at Record Currency Management, which oversees about $53 billion in assets. "We went into the Brexit vote short pound through our models." A short position is a bet that an asset will decline in value.
It’s the first time since 2014 and just the second time since 2005 that all three strategies are set to rally. Yet amid the strong performance, many foreign exchange investors have struggled this year. Some misjudged the impact monetary stimulus would have on the yen, while others were pummeled by volatility after Brexit.
"You’ve got to be nimble and be able to adjust," said Axel Merk, San Francisco-based founder of Merk Investments LLC, which manages $300 million in assets.
At the same time, sound monetary policy analysis has created the conditions for trusted foreign-exchange strategies to profit.
"The biggest development in central-bank policy this year is central banks making it explicit that currency moves are part of their monetary-policy-response function," said Collin Crownover, head of currency management at State Street Global Advisors Inc., which oversees about $2.4 trillion. "People are looking for yield and they are not as worried about certain currencies being overvalued anymore."