Dollar slump, overcrowding complicate popular FX carry trade

London, July 26 (BNA): A slide in the dollar and signs that volatility is returning to foreign exchange markets as interest-rate hikes bite is causing investors to reassess wildly popular carry trades and to be pickier about which currencies they back.

 

The carry trade – an investment strategy that takes advantage of differences in borrowing costs between countries – has provided bumper returns this year as most central banks have hiked rates, causing yields to rise, but at different paces, Reuters reported.

 

“The world’s favourite carry trade,” according to Bank of America, involves investors borrowing Japanese yen where the central bank has pinned rates low, and converting them to Mexican peso to buy much higher-yielding bonds.

 

One-year bond yields are about 0.1% in negative territory in Japan , but their Mexican counterparts yield around 11%.

 

A hypothetical $50,000 invested in a short yen, long peso carry trade for the first six months of the year would have yielded a profit of $15,100, according to Refinitiv Eikon.

 

“Carry has been very much in focus in the first half of the year,” said Kamakshya Trivedi, head of global FX, rates and EM strategy at Goldman Sachs.

 

“Something like 70% of the cross section of moves (in EM currencies) can be explained by carry.”

 

Deutsche Bank’s emerging market carry strategy index had its best year on record in the 12 months to May.

 

But the trade could be jolted this week as the Federal Reserve, European Central Bank and Bank of Japan all set interest rates and give clues on the monetary policy outlook.

 

F.K.N.