Carry trade makes a comeback

The NZ dollar jumped 3.9 per cent against the yen after the tsunami. Photo / Thinkstock

Currency carry traders are coming back to the local market as returns rebound from two-year lows and the Federal Reserve and Bank of Japan show no urgency to raise interest rates.

Investing the proceeds of yen loans in New Zealand dollar-denominated assets has earned 311 per cent in annual terms since March 17 (the day before the Group of Seven sold yen to help Japan stem currency appreciation), data from Bloomberg shows.

Borrowing in US dollars to invest in Brazil reals has earned 104 per cent. The carry trade is reviving as traders step up bets that the Fed and BOJ will keep target interest rates at record lows for longer than anticipated earlier this year.

While stronger currencies may help economies such as New Zealand damp inflation, they also risk curbing exports they rely on to bolster growth.

"The dollar and the yen are good funding currencies as their rates are so low now," said Tsutomu Soma, a bond and currency dealer at Okasan Securities in Tokyo. "The yen is especially ideal as Japan won't be able to raise rates for a very long period of time due to the earthquake and the intervention may prevent the yen from rising."

The Bank of Japan's overnight lending rate of between zero and 0.1 per cent and the federal funds target rate of zero to 0.25 per cent mean investors can borrow at rates far below what they can earn in Australia, where the central bank cash rate is 4.75 per cent, and Brazil, whose benchmark Selic rate is 12 per cent. The Australian dollar has appreciated 9.3 per cent against the yen since the G7 move and the real has strengthened by 7.8 per cent.

Carry-trade returns soared after March 2009, as the Fed slashed interest rates to revive the US economy following the financial crisis. The UBS V24 Carry Index soared to 538.6 last April from about 480 a year earlier.

Returns then diminished, with the UBS index falling to 486.5 on March 18, on speculation the global economic recovery was gaining strength. Japan's earthquake and tsunami and a slowdown in the US quashed optimism that rates would soon rise in the US, sparking more demand for carry trades. A Government report this week may show the US economy's growth rate slowed to 2 per cent in the first quarter from 3.1 per cent in the final three months of last year, estimates in a Bloomberg survey show.

Yen investors piled into currencies including the NZ dollar as the world's major central banks pushed down the yen. The kiwi dollar jumped 3.9 per cent against the Japanese currency on March 18.

The G7 acted after speculators betting that Japanese insurance companies would repatriate funds had sent the yen up as much as 4.7 per cent against the US dollar on March 17.

The revival of the carry trade coincided with a surge in other risky assets, with the MSCI World Index rising 5.5 per cent since March 18.

Net short positions in the Japanese yen were at the highest level since last May, according to April 5 data from the Commodity Futures Trading Commission compiled by Bloomberg. A net short position means investors have bought more contracts to sell the yen than to buy it, and implies they are betting on a decline in the currency.

Investors' positioning in the New Zealand dollar flipped from net short before the G7 intervention to net long afterwards. New Zealand's consumer price inflation accelerated to 4.5 per cent in the first quarter of the year, from 2 per cent in the same period of last year. Brazil's inflation was 6.3 per cent in March and South African prices rose 3.7 per cent in February.

"More funds will move to higher yielding countries," said Kenichiro Ikezawa, a fund manager at Daiwa SB Investments in Tokyo.

"People are probably shifting from the dollar carry to the yen carry as it is possible the US may raise rates, while Japan will probably have to keep rates low for a much longer period."

- BLOOMBERG