Carry Trade Comeback Means Biggest Gains Since 1999

(Bloomberg) -- The carry trade is making a comeback after its longest losing streak in three decades.

Stimulus plans and near-zero interest rates in developed economies are boosting investor confidence in emerging markets and commodity-rich nations with interest rates as much as 12.9 percentage points higher. Using dollars, euros and yen to buy the currencies of Brazil, Hungary, Indonesia, South Africa, New Zealand and Australia earned 8 percent from March 20 to April 10, that trade’s biggest three-week gain since at least 1999, data compiled by Bloomberg show.

Goldman Sachs Group Inc., Insight Investment Management and Fischer Francis Trees & Watts have begun recommending carry trades, which lost favor last year as the worst financial crisis since the Great Depression drove investors to the relative safety of Treasuries. Now efforts to end the first global recession since World War II are sending money into stocks, emerging markets and commodities.

“The global economy seems to have reached an inflection point,” said Dale Thomas, head of currencies at Insight Investment Management in London, which oversees $121 billion. “We’re set for a period of some classic risk currency trades, where you sell the dollar against emerging-market currencies.”

Carry trades use funds in countries with lower borrowing costs to invest in those with higher rates, allowing investors to pocket the difference. Speculators fled the strategy last year as central banks cut rates to revive growth, narrowing spreads, and as currency swings increased risks. Foreign- exchange volatility expectations surged 73 percent in three days to a record on Oct. 24, a JPMorgan Chase & Co. index shows.

Aussie, Real

Thomas recommends the Australian dollar and real in Brazil, where the benchmark central bank rate is 11.25 percent, or about 11 points more than the corresponding U.S. rate.

Borrowing U.S. dollars at the three-month London interbank offered rate of 1.13 percent and using the proceeds to buy real and earn Brazil’s three-month deposit rate of 10.51 percent rate would net an annualized 9.38 percent, as long as both currencies remain stable.

Carry trades were profitable for most of the past three decades. They produced average annual returns of 21 percent in the 1980s with no down years, the best of four commonly used currency strategies, according to ABN Amro Holding NV indexes.

Three Down Years

In the 1990s, carry-trade investors suffered three down years, including a 54 percent slide in 1992, ABN Amro data compiled by Bloomberg show. From 2000 to 2005, the trade was again on top with average gains of 16 percent.

Then it dropped three years in a row in 2006-08, the longest streak since 1976-78, for an annualized average loss of 16.5 percent through Feb. 28. Most of the decline came after June 2008 as the collapse of U.S. subprime mortgages froze credit markets and led to the bankruptcy of New York-based Lehman Brothers Holdings Inc., the biggest corporate failure in history.

As investors fled to the safest assets, the greenback climbed 26 percent between July 15 and March 4, when it reached its highest in almost three years, according to the Intercontinental Exchange Inc. Dollar Index against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona. Prices for Treasuries rose, sending the 10-year note yield to a record low of 2.0352 percent on Dec. 18, from 4.07 percent on Oct. 14.

Read more at Bloomberg