FX Carry Trades Suffering on Tapering Fears

Some investors have gotten past the market turmoil that erupted when Ben Bernanke first hinted that the Federal Reserve might scale back its bond buying later this year. Not those who play the carry trade in the currency market.

The foreign-exchange carry trade is a way for investors to profit from differences in interest rates by borrowing currencies with low yields and using them to buy assets denominated in higher-yielding counterparts. This had been done with the low-yielding yen for many years.

But when concerns that the Fed would slow its monthly asset purchases of $85 billion started surfacing in May, the trade fell apart. Bernanke “exacerbated” these fears when he told members of Congress in May that the central bank could begin slowing its purchases “in the next few meetings,” Nomura’s Ankit Sahni and Jens Nordvig wrote in a note.

Late May into the first half of June was an especially bad period for carry trades based on shorting the yen because Fed fears coincided with a fall in the Nikkei and a rise in the yen against the dollar, said Nordvig, global head of G10 FX Strategy, in an interview. A short on the yen is a bet that its value will decline.

“Increasingly, market expectations were built around a reduction in the pace of asset purchases later in 2013. This resulted in a level shift higher in perceived risk and volatility, causing significant underperformance of these carry trades. But the size of the drawdown diverged significantly among assets,” the Nomura analysts wrote.

MarketWatch

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