Carry Trade Comeback Could Hurt Euro

Borrow-low, invest-high carry trades in foreign exchange markets are back again after a bad few months, as anticipation of a U.S.-led global recovery lures investors to return to risky emerging currencies, with the euro a likely loser.

In demand are the currencies of the “fragile five” countries highly reliant on foreign capital – the Turkish lira, the South African rand, the Brazilian real, the Indonesian rupiah and the Indian rupee.

All five were shunned for much of last year because of fears the winding down of U.S. monetary stimulus would see funds withdrawn from emerging markets.

But the options market indicates a rally may have legs, as gauges of how choppy the major currencies will be have fallen, encouraging investors to take on more risk in search of returns.

Such risk-seeking trades, in which investors borrow in a low-yielding currency to buy a higher-yielding one, are especially popular among nimble asset managers, speculators and hedge funds.

They have provided steady long-term returns but struggled in the first quarter of this year because of concerns about a sharp economic slowdown in China and a flare-up between Russia and the West over Ukraine, which could undermine a global recovery.

The biggest danger for the carry trade is volatility: the prospect that a sudden fall in the riskier currency will wipe out the profits from investing at a higher interest rate.

But such worries have eased somewhat, allowing investors to focus on monetary policy divergence and macro-economic trends.

While the U.S. Federal Reserve is gradually unwinding its bond-buying stimulus programme and expectations are it may tighten policy in the middle of 2015, the European Central Bank and the Bank of Japan are both pledging to flood markets with cash to support growth and avert the risk from deflation.

via Reuters

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza