Monday, August 8

Carry Trade Comes Surging Back With Biggest Returns Since 2016

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(Bloomberg) — The returns on carry trades are roaring back in the currency markets of the world’s major developed countries, thanks to surging commodity prices, low volatility and the growing ranks of central banks that are tightening monetary policy.

The combination has allowed traders to reap the biggest profits in five years from such trades, which involve borrowing in nations where interest rates are still low and investing in those where yields are higher.

The Bloomberg Cumulative FX Carry Trade index for G-10 currencies — which tracks the daily rebalanced returns of borrowing in the three lowest-yielding currencies and investing in the three highest yielding — has returned 3.6% in the last two months. That’s pushed it to a gain of over 8% so far this year, on pace for the biggest annual rise since 2016.

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“The two strategies that have worked best recently have been carry and terms of trade-based ideas,” said Shaun Osborne, the chief foreign-exchange strategist from Scotiabank. “Carry works in a benign, low volatility environment — which is what we have had with all the central bank stimulus in place.”

Those gains stand in stark contrast to the losses that have piled up in the sovereign bond markets worldwide, where prices have slid since central banks began raising interest rates and pulling stimulus from their economies. The Bank of Canada joined in that hawkish shift Wednesday when it decided to stop its asset purchases; meanwhile, rising inflation led traders to increase bets on an Australian rate hike.

But the moves have been uneven, with the US, Japan and European Central Bank yet to act, even as nations such as Brazil, New Zealand and Russia increase key benchmark rates. At the same time, volatility among the major currencies has declined and those such as the Australian dollar and Norwegian krone have gained on the backs of rising commodity prices.

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“The global front-end has been repriced and central banks have turned more hawkish — some more so than others — which means that it does not pay to be owning the funding currencies,” said Mazen Issa, a senior foreign exchange strategist with TD Securities . “We have been pushing this view that investors should be long currencies against the traditional funders like the euro, franc and yen.”

So far the gains have largely been limited to the developed world as volatility dampens those in emerging markets.

The krone, New Zealand dollar and British pound were the top yielding Group-of-10 currencies over a three-month time horizon. The Canadian dollar isn’t far behind.

By comparison, indexes for carry trades into emerging-market currencies have had mixed results. While some high-yielding currencies such as the ruble have risen against the dollar, others, like the Turkish lira and Brazilian real, have plunged. This has left the Bloomberg Cumulative FX Carry Trade index for 8 emerging markets down slightly this year.

Erik Nelson, a Wells Fargo Securities strategist, said the returns from carry trades may begin to fade as shortage-fueled commodity prices ease and more central banks begin to normalize monetary policy.

“I can’t help but wonder if we’re reaching a cresting point in the pro-carry wave,” he said.

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