Carry-Trade Revival Buoys Currency Investors Reeling From Shocks

  • Returns surge by most since 2012 as ECB, BOJ maintain stimulus
  • Hedge fund ROW borrows to buy in Turkey, S. Africa, Indonesia

At last, currency traders are finding some traction.

The carry-trade strategy, in which investors borrow in currencies with low interest rates and use the proceeds to buy an asset with higher rates, surged in October after posting losses for most of the year, according to a UBS Group AG index. That’s convinced hedge fund ROW Asset Management LLC to bet on emerging-market currencies and prompted JPMorgan Chase & Co. to recommend buying the Russian ruble and Polish zloty.

“The high yielders present value because they’ve been beaten up so badly,” Philip Simotas,  ROW’s chief operating officer, said in an interview in New York. “Those yields just become too juicy to pass up.”

The Newport Beach, California-based company, which manages $435 million, is buying the currencies of Turkey, South Africa and Indonesia, funded by lower-yielding counterparts such as the euro and yen.

Carry trades returned 4.7 percent in October, the most since January 2012, according the UBS Group AG V24 Carry Index. The results reflect rallies of more than 8 percent for Indonesia’s rupiah against the euro, 5 percent for the Turkish lira and 4 percent for the Russian ruble.

The strategy’s success reflects volatility falling from a September peak and attractive rates for investors borrowing in the euro and yen. The prospect for even more central-bank stimulus in Europe and Japan is stoking demand for riskier assets and marks a turnaround after carry trades lost 8.3 percent in August, the most in at least 16 years, when China shocked global financial markets by devaluing the yuan.

The October carry-trade rebound doesn’t mitigate all the challenges in the foreign-exchange market. The Parker Global Strategies LLC index of currency managers’ returns fell the past two months, extending this year’s loss to 2.4 percent.

Carry-trade returns may evaporate, with possible triggers including economic data or speeches from monetary policy makers, said Richard Franulovich, chief currency strategist for the northern hemisphere at Westpac Banking Corp. in New York.

In October, 38 of the 43 potential carry trades funded in euros made money, the most to deliver positive returns since March, according to data compiled by Bloomberg. Investors piled into the strategy after European Central Bank President Mario Draghi hinted on Oct. 22 at additional stimulus measures, which typically depress a currency.

Tactical Approach

“I have a lot of sympathy for playing carry from a very tactical, short-term perspective,” Franulovich said. “There are definitely moments where central banks are acting in ways to give it a boost.”

Forecasters predict most of the 23 emerging-market currencies tracked by Bloomberg will strengthen against the euro and yen by the end of the year, with gains being led by the Malaysian ringgit, Indonesian rupiah and South African rand. Borrowing costs measured by one-year government debt are about negative 0.25 percent in the euro area, compared with 2.8 percent in Malaysia and 8.1 percent in Indonesia.

With the UBS carry index down 8.2 percent this year even after the October gains, the risks of diving back into higher-yielding currencies suggest caution for some analysts.

“I would be worried about the sustainability of those trades,” said Jeremy Lawson, the Edinburgh-based chief economist at Standard Life Investments Ltd., whose company manages $393 billion. That’s because exchange rates are especially susceptible to big moves, particularly when central bankers speak, he said.

For example, “if the New Zealand dollar appreciates too much, I don’t think it will take long before the Reserve Bank of New Zealand governor starts talking the currency down,” he said. A rising kiwi is jeopardizing RBNZ Governor Graeme Wheeler’s attempts to return inflation to his 2 percent target midpoint for the first time since 2011.

Amid the revival of carry returns, JPMorgan recommends a short-term strategy betting the ruble and zloty will appreciate versus the euro.

“It’s hard to become enthusiastic about foreign-exchange carry for more than a couple of months,” John Normand, JPMorgan’s head of foreign exchange, commodities and international rates research, wrote in a note Oct. 23. “Buy into carry only selectively.”

Before it's here, it's on the Bloomberg Terminal.