Mexican Peso, Rupiah Carry-Trade Burnished by Low VolatilityBy and
Peso, rupiah most attractive of 26 peers in Bloomberg analysis
Gauge of emerging-market carry trades has gained 5.5% in 2017
Sliding volatility in global currency markets is increasing the allure of carry trades and the most appealing targets are the Mexican peso and Indonesian rupiah, according to a Bloomberg analysis.
A JPMorgan & Chase Co. gauge of global foreign-exchange volatility dropped to 8.2 percent on Tuesday, the lowest level since November 2014, and down from as high as 12.5 percent in February 2016. An index of carry-trade returns from eight developing nations against the dollar has risen 5.5 percent this year, set for its biggest annual gain since 2012.
“Emerging-market currencies are on a better footing as their valuations have become reasonable, the economies are improving and commodities are stabilizing,” said Kengo Suzuki, chief currency strategist at Mizuho Securities Co. in Tokyo. A U.S. economy that’s neither too strong nor too weak means the pace of tightening by the Federal Reserve won’t accelerate, keeping volatility low, he said.
In a carry trade, investors typically borrow in developed nations to tap into higher interest rates abroad, earning the spread between the two. The risk is currency moves will wipe out profits.
The strategy has been a bright spot for investors amid a global hunt for yields. Higher interest rates and appreciation in emerging-market currencies against the dollar have garnered carry returns of 10 percent for the peso and 2.9 percent for the rupiah this year. To be sure, the difference in borrowing costs alone isn’t enough for traders to close their eyes to political events.
The peso, for instance, has been on a roller-coaster ride since Donald Trump won the U.S. election. It fell to record lows earlier before Trump’s inauguration on fears he would undo the trade pact that transformed Latin America’s second-largest economy into an export powerhouse, only to rebound sharply as it looked like those concerns were overdone.
On Thursday, the peso and Canada’s dollar jumped after Trump said he wasn’t going to quit Nafta at this time, just a day after reports his administration plan to undo the accord. The flip-flop pushed the peso up 0.9 percent following a 1.7 percent loss the day before.
Bloomberg’s analysis ranked 26 developed and emerging markets in terms of a carry-to-risk ratio that compares interest-rate differentials with implied currency volatility.
The carry-to-risk ratios for the Mexican peso and Indonesian rupiah show the greatest premium over their five-year average among the currencies analyzed. A separate measure shows the two are not overstretched, being more undervalued than their average since 2012.
The carry-to-risk ratio is computed by subtracting the U.S. dollar’s three-month deposit rate from that of the local currency, and dividing that by three-month implied volatility. PPP Valuation refers to a deviation of the spot exchange rate from an equilibrium rate implied by purchasing-power parity. PPP data are from the International Monetary Fund.
The analysis covers the 26 currencies that are either members of the Group of 10, JPMorgan Chase & Co’s Emerging Market Currency Index or Asia Dollar Index. Half of the currencies have lower deposit rates than the U.S. dollar. The Chilean peso is excluded owing to a lack of comparable data.
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— With assistance by Nicholas Reynolds