Carry on – central bank signals let "carry" traders hunt more

LONDON (Reuters) – The collapse in badet price volatility has turned "carry trading" into one of the most popular investor games in 2019. Many believe the race is far from over.

According to this strategy, investors are borrowing in currencies with low interest rates to invest in high-yielding countries, such as emerging markets. Investors can pocket the difference or "wear".

For trade to function, liquidity must be abundant, the global economic context unclear and, most importantly, the volatility of currencies almost nil. Basically, all these conditions seem to be in place.

Volatility, or volume, was crushed this year by central banks' decision to pause interest rate hikes. Societe Generale badyst Kit Juckes said the "total boredom" of the markets until 2019 was the perfect recipe for the success of the carry trade – exchange rate volatility is almost at its lowest level for many years. years.

As a result, carry trade yielded 5.5% in 2019, according to the HSBC Global FX Carry Index. This follows a 1.4% decline in 2018, as rising US interest rates spurred a rush into emerging markets, the favored place to make money.

The current carry environment is a "manual", says Andreas Koenig, Head of Foreign Exchange Operations at Amundi Asset Management.

(Chart: HSBC Global FX Reference Index Excess Return Index – tmsnrt.rs/2F9EowR)

SELL AND BUY

Koenig bet on the Turkish lira and the Brazilian real, both offering double-digit returns.

Investors who buy 10-year Russian government bonds can earn a yield of 8.5%, or 8% in Mexico. The appreciation of the currency further strengthened these returns – some emerging currencies such as the ruble strengthened by up to 6% against the dollar and the euro.

On the other hand, the Japanese Yen, the Swiss Franc and the Euro tend to be the preferred financing currencies of traders, their low yields making them attractive for sale.

Performance in Switzerland on the return of the benchmark bond -0.35%; in Germany, barely 0.07%. But the euro has been particularly popular this year as the troubled economy has further delayed tightening policies in the bloc.

(Graphic: Comeback for carry – tmsnrt.rs/2O2a6iz)

But can the good times last?

Analysts say the carry trade has been around for a while, or at least as long as rates stay low and economic data is strong, but not so strong that it forces a central bank to rethink.

BNP Paribas predicts that short-term growth in major economies will be "not too cold, but certainly not hot.

"The poor economic outlook means we are in favor of long carry trades and short volatility," the bank's economists wrote last week.

Bad performance

As history shows, the carry hunt is not without risks.

If US growth worsened, international trade conflicts worsened, or crystallized late one decade, the resulting spike in volatility can send "safe" currencies like the yen. , the euro and the Swiss franc up, while inflicting losses on the riskier emerging markets.

But even in a good porting environment, some high yield transactions may not work. For example, the MSCI Emerging Currencies Index is up 1.6% in 2019 after falling 3.8% last year, but gains mask poor individual performance.

Robin Brooks, an economist at the Institute for International Finance, notes that since the reversal of the Federal Reserve's surprise policy in January, high-yielding securities such as the South African rand and the Turkish lira have in fact weakened.

Asian currencies, including the Indian rupee and the Malaysian ringgit, have won – a "puzzle" that Brooks attributes to expectations of a trade deal between China and China rather than to investors reacting to the radical change in the Fed.

(Chart: Emerging markets currency performance in 2019 – tmsnrt.rs/2Cg2cxu)

Investors have also already strengthened their carry positions: speculators have a net net worth of $ 2.3 billion against the US dollar, compared to a neutral position in January, according to the CFTC positioning data.

(Chart: Speculators speculate on the Mexican peso – tmsnrt.rs/2FbJ996)

Amundi's Koenig said that after the strong rally in high-yielding currencies in 2019, "risk is not only linked to volatility, but also to underlying levels.

"Takeaway from here is not my favorite strategy," he said. "At the end of the cycle, it's unlikely to last forever."