Carry Trade Loss 2.8% as Dollar Fails to Weaken on Fed Reply

By Monami Yui, Masaki Kondo and Hiroko Komiya – Sep 10, 2012 9:42 AM ET

Central bankers will get a lot less bang for their buck, pound, euro and yen as they struggle to stimulate flagging economies, trading strategies in the $4 trillion a day foreign-exchange market suggest.

The UBS AG V24 Carry Index, which measures returns from borrowing in lower-rate currencies to buy higher-yielding ones for so-called carry trades, has fallen 2.8 percent from a four- month high on Aug. 9. Bloomberg Correlation-Weighted Indexes show that the worst-performing major currency in the past month was the Australian dollar, typically a beneficiary when investors are bullish on the economy because the nation has the highest interest rates among developed economies.

From the $2.3 trillion pumped into the U.S. by the Fed since 2008 to record-low interest rates in the euro zone, U.K. and Japan, nothing has prevented the world’s economy from slowing this year. Foreign-exchange traders are signaling they expect little improvement any time soon, and that’s a change from the past. After Chairman Ben S. Bernanke flagged $600 billion of quantitative easing, or QE, in August 2010, the carry trade gained 3.1 percent in 30 days.

“I can’t be optimistic that investor sentiment will improve rapidly and the world’s economy will pick up,” Yoshisada Ishide, who oversees $14 billion as the manager of the biggest mutual fund focused on Australian dollar-denominated debt at Daiwa SB Investments Ltd. in Tokyo, said in a phone interview on Sept. 7.

That outlook echoes Yale University professor Stephen Roach and Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. They say central bank money printing is losing its effectiveness in spurring growth.

‘Excessive Fat’

“I’ve been negative about the U.S. ever since the Fed went to their unconventional monetary policy,” Roach, the former non-executive chairman for Morgan Stanley in Asia, said in a Bloomberg Television interview on Sept. 6.

“Our credit-based financial system is burdened by excessive fat and interest rates that are too low,” Gross, who oversees Pimco’s $270 billion Total Return Fund, wrote in the monthlycommentary posted on Pimco’s website Sept. 5.

Falling demand for commodity imports in China sent the Australian dollar down 3.6 percent over the past month, the biggest drop among the 10 developed-nation currencies tracked by the Bloomberg indexes. That contributed to a 9 percent decline since August 2011 for carry trades funded by the dollar and invested in the so-called Aussie, South African rand, Brazilian real and Mexican peso.

Strategy Reversal

Carry trades had returned almost 80 percent from March 2009 through July last year as investors took advantage of lower borrowing costs in developed markets to buy assets in emerging and resource-producing nations. Benchmark interest rates in the Group of 10 will average about 0.53 percent this year, compared with 6.39 percent for Brazil, Russia, India and China, according to data compiled by Bloomberg.

The dollar sank 1 percent last week according to the Bloomberg index, after the U.S. Labor Department said the economy added 96,000 jobs in August, below the 130,000 median estimate of 92 economists surveyed by Bloomberg. The dollar advanced 0.2 percent to $1.2793 per euro as of 8:40 a.m. in Tokyo. It was little changed at 78.23 yen.

Concerns that growth will continue to deteriorate gives the Fed room to signal a third round of bond purchases as early as this week. A gauge of indicators used to measure expectations for Fed stimulus rose to 99 percent in August, the highest ever, according to Citigroup Inc.

Policy makers began injecting money into their economies after the collapse of Lehman Brothers Holdings Inc. four years ago this week sparked the biggest financial crisis since the Great Depression.

Global Stimulus

After the Fed’s first round of quantitative easing, the Bank of England announced 75 billion pounds ($120 billion) of asset purchases in March 2009, and the European Central Bankprovided 442 billion euros ($566 billion) in one-year loans to the region’s lenders in its Long Term Refinancing Operation, or LTRO, three months later. The Bank of Japan said in October 2010 it would buy 5 trillion yen ($64 billion) of government and corporate debt.

The unprecedented actions came with interest rates already at or about record lows. The Fed cut its overnight bank lending rate to between zero and 0.25 percent in December 2008 and has indicated it may keep it there through 2014. The ECB has reduced borrowing costs to 0.75 percent and the BOE to 0.5 percent. The BOJ lowered its target rate to about zero from 0.5 percent.

Dollar Falls

Fed stimulus has typically debased the currency. IntercontinentalExchange Inc.’s Dollar Index (DXY) tracking the greenback against six U.S. trading partners, dropped 13 percent between the Fed’s announcement of $2.3 trillion in easing in November 2008 through the end of the bond buying in June 2011.

That might not happen this time. While the index fell 2.4 percent in the last month to 80.25, it’s still within 5 percent of a two-year high of 84.10 reached on July 24. Bloomberg Correlation-Weighted Indexes show New Zealand’s currency weakened 2.3 percent in the past month, the biggest decline after the so-called Aussie dollar.

The political backlash over QE has been fierce. Republicans called for an audit of the Fed in their 2012 platform adopted in Tampa, Florida, on Aug. 28. Senator Bob Corker of Tennessee said in a press release Sept. 6 that an “unhealthy obsession” with monetary policy is distracting the public from the need for fiscal reform. The Fed’s balance sheet has swelled by almost threefold since the collapse of Lehman to $2.81 trillion.

“We’re seeing clearer signs of diminishing returns from success of quantitative easing programs,” Robert Rennie, chief currency strategist at Sydney-based Westpac Banking Corp., Australia’s second-largest lender, said in a telephone interview on Sept. 5.

Stocks Rally

Carry trades may benefit from a resolution for Europe’s debt turmoil. Prospects for a cure rose when ECB President Mario Draghi announced on Sept. 6 an unlimited bond-buying program to damp yields in the euro area and fight speculation that Greece might leave the 17-nation currency union. Purchases will be sterilized, meaning the money supply won’t grow.

Global stocks and riskier currencies rallied. The 17-nation euro strengthened 1.9 percent last week to $1.2816, the highest closing level since May 21, while the Australian dollar added 0.6 percent to $1.0385. The MSCI World Index (MXWO) jumped 2.6 percent in the five days through Sept. 7 to a five-month high.

“We’re pretty bearish on the dollar,” Mary Nicola, a New York-based currency strategist at BNP Paribas SA, France’s largest bank, said Sept. 5 in a telephone interview. “We see weakness against the commodity currencies.”

China Slows

BNP estimates the Dollar Index may fall to 76.4 by the end of June, the lowest projection among 10 analysts in a Bloomberg survey. The median of their forecasts signal the gauge will advance to 82.4.

Signs that China is losing steam may dent economies such as Australia that depend on the world’s second-largest economy to buy their commodities.

Manufacturing contracted in China at the fastest pace in August since March 2009, according to the purchasing managers’ index released by HSBC Holdings Plc and Markit Economics on Sept. 3.

Even a calming of currency price swings that normally would benefit the carry trade is having little effect. The JPMorgan G7 Volatility Index fell to 8.03 percent on Sept. 7, the lowest since October 2007, and down from its record 26.55 percent in October 2008. A smaller number means the potential profit from carry trades is more predictable, boosting the allure of the strategy.

Awaiting Storm

“Volatility is low simply because people are staying on the sidelines, awaiting the next storm,” Masashi Murata, a currency strategist in Tokyo at Brown Brothers Harriman & Co., said in a telephone interview on Sept. 6. “Conditions for carry trades aren’t being met.”

The U.S. may tip into recession next year if lawmakers can’t break an impasse over the federal budget, according to report from the nonpartisan Congressional Budget Office. Economic output would shrink next year by 0.5 percent, and joblessness would climb to about 9 percent, unless $600 billion in scheduled tax increases and spending cuts are halted, the CBO said Aug. 22.

‘Weakest Recovery’

“What the record shows is we’ve had the weakest recovery on record, we have anunemployment rate above 8 percent, and the U.S. consumer is basically dead in the water,” Yale’s Roach said on Bloomberg Television’s “First Up” with Susan Li.

The rest of the developed world isn’t much better off. The euro-zone and U.K. economies contracted 0.5 percent in the second quarter from a year earlier. Japan is struggling to overcome more than a decade of deflation and the effects of last year’s record earthquake.

New regulations requiring banks to hold more capital and increased saving by households has prevented record low interest rates from sparking the recovery central bankers anticipated, Gross wrote in the monthly commentary posted on Pimco’s website Sept. 5.

“Returns from both stocks and bonds will be stunted,” Gross said. “Central banks are agog in disbelief that the endless stream of QEs and LTROs have not produced the desired result.”

To contact the reporters on this story: Monami Yui in Tokyo at; Masaki Kondo in Singapore at; Hiroko Komiya in Tokyo


Source: Bloomberg


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