More Pain Seen for Worst FX Strategy as Carry Traders Suffer

(Bloomberg) -- For one of the most popular trading strategies in the $5.1 trillion-a-day currency market, the past year has been difficult and the prospect of respite any time soon seems remote.

Carry trades, or borrowing where interest rates are low and investing the proceeds where they’re higher, are set for a fourth straight quarter of losses despite the relative calm of foreign-exchange rates over the past three months. For analysts, the potential for rising volatility amid escalating global trade tensions suggests there’s little hope of a turnaround on the horizon.

“I just don’t see the carry trade as being the operative trade,” said Marc Chandler, a strategist at Brown Brothers Harriman & Co. “Even though the interest rate differentials are wide, the funding currencies are not depreciating.”

A surging yen -- one of the most favored funding currencies -- is largely to blame for the strategy’s poor performance this quarter. Even with Wednesday’s slide, it’s strengthened more than 6 percent since the start of the year amid turmoil in global stocks, expectations for diminished Bank of Japan accommodation and a domestic political scandal. Shorting the yen would’ve offered negative returns against 28 of 31 major currency peers in the span, according to data compiled by Bloomberg.

That’s despite a JPMorgan Chase & Co. gauge of price swings in global currencies averaging just 7.90 percent over the past three months, compared to 8.44 percent last year and 10.61 percent in 2016. Now, escalating trade tensions between the U.S. and China threaten to disrupt the FX market’s serene stretch, potentially swallowing up the yield difference that carry traders profit from.

“The yen carry trade has been under a lot of pressure lately with the rapid appreciation of the JPY,” said Sireen Harajli, a foreign-exchange strategist at Mizuho Bank Ltd. She called the wager a “risky trade.”

A Deutsche Bank AG index tracking carry trade returns in aggregate has slid 0.8 percent year-to-date, underperforming other strategies such as buying and selling based on relative value and following trends.

Gains for the Swiss franc have also contributed to this year’s slump in carry strategies, according to Bob Savage, chief executive officer of Track Research, a website for investment research.

The strategy isn’t dead, it’s just “feeling rather ill,” he said.

More structural factors are also at play amid the carry trade’s long-term decline. The prospect of higher interest rates in developed economies as central banks dial back post-crisis stimulus is lessening the carry trade’s appeal, according to Mark McCormick, North American head of FX strategy at Toronto-Dominion Bank.

“The global regime shift in markets suggests that markets are moving from carry and momentum style trades to a valuation-based approach," McCormick said. “As the backdrop for capital flows shift alongside central bank normalization, carry-based strategies should see big drawdowns as volatility starts to normalize.”

To contact the reporters on this story: Alexandria Arnold in Seattle at abaca3@bloomberg.net, Lananh Nguyen in New York at lnguyen35@bloomberg.net.

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Boris Korby

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