22 Apr 2009, Christopher Whittall, Risk magazine
Carry trades - where traders earn profits by taking advantage of interest rate differentials between currencies - have taken a pummelling over the past 18 months. But in an April report on global foreign exchange strategies, Goldman Sachs analysts pointed out that market conditions indicate a return to certain carry strategies could reap rewards.
Goldman analysts cited several factors that indicate carry trades could make a comeback. First, with global imbalances having been reduced, interest rate moves - a key determiner for carry trades - are less likely. Second, action from central banks and international bodies such as the International Monetary Fund mean ailing economies - and their deteriorating currencies - are likely to be propped up. Third, central banks of countries whose currencies are used in funding carry trades, such as Switzerland and Japan, have taken measures to check the appreciation of these currencies. Fourth, Goldman analysts pointed to increasing signs that forex volatility has peaked. Fifth, the broader macroeconomic outlook has improved recently.
The report recommended the Mexican peso, the Indonesian rupiah, the Indian rupee and the South African rand as "very attractive" carry currencies, while opting for the Swiss franc and Singaporean dollar along with the G-3 currencies on the funding side.
"The performance of different carry baskets suggests that there are early signs of improvements and some positive returns, but not all carry specifications have performed strongly yet," the report stated.
But other analysts disagree. "At the moment, it is forex driving interest rates. You usually have carry trades when it is the other way around and rates are driving forex. Some people are talking about a possible comeback of carry trades, but I do not think that carry trades will come back anytime soon," said Murat Toprak, an emerging markets forex strategist at Société Générale in London.
"I think people who invested in carry trades lost so much money they would greatly reconsider carry as a viable play right now - volatility is so much higher that you cannot trade on a pure carry perspective," said Shahin Vallee, a London-based currency strategist at BNP Paribas.
Forex volatility has dropped from a high of 24.24 on October 27, 2008, to 14.67 on April 21, according to the Deutsche Bank FX volatility index. Nevertheless, it is still at historically high levels: average forex volatility from June 2006 to June 2007 was 6.80.
In any case, there seem to be few investors brave enough to consider carry at the moment. "People are starting to talk about it because we've had a rally on the equity market over the past six weeks, and some trades like South African rand against the yen worked. But, in general, we are not seeing this kind of appetite to place carry trades," comments Toprak.
Vallee points to other factors driving the appreciation of high-yielding currencies, particularly China's renewed appetite for imports. According to the China General Administration of Customs, coal imports have more than doubled to 4.88 million tons on February 28 from 2.17 million tons on November 30, 2008, while iron ore and concentrate imports have leapt to 52.08 tons as of March 31 from 30.62 million tons on October 31, 2008.
"We have seen a change in pattern in emerging market and high-yielding currencies, but it would be inaccurate to put this down to carry. There is a rebound in commodity currencies: the Australian dollar, South African rand, Latin American currencies and the South Korean won. This is being driven by what looks like a rebound in the Chinese economy and a demand for commodities," says Vallee.