Carry trades less popular in NZ dollar market

Photo / Kenny Rodger

The popularity of the so-called carry trade in the New Zealand dollar market has decreased during the global financial crisis, according to an article in the Reserve Bank Bulletin.

Increased volatility reduced the appeal of the carry trade investment strategy and the NZ dollar has become less of a focus for international traders.

"It remains to be seen whether, as markets gradually return to an environment of lower volatility and increased risk appetite, the popularity of the NZ dollar will return to pre-crisis levels," the article on global currency trends through the financial crisis, by Zoe Wallis, said.

Overall, the volume of foreign exchange turnover has increased during the crisis between 2007 and 2010 but the per centage share of NZ dollar trades has fallen to 1.6 per cent in 2010 from 1.9 per cent in 2007.

Demand for carry trades, particularly in the NZ dollar, has fallen and demand for safe haven currencies such as the US dollar and Japanese yen has increased through the crisis.

New Zealand attracted considerable inflows of capital in the lead-up to the financial crisis when the carry trade was very attractive.

Since 2000, the interest rate spread between New Zealand and the US widened, reaching a peak of almost 500 basis points prior to the start of the crisis.

Since early 2008, New Zealand interest rates have fallen below those in Australia, a phenomenon not seen since the end of 1995.

"With interest rates in Australia and other commodity-linked currencies, such as the Brazilian real, now relatively more attractive compared to interest rates in New Zealand, the carry trades that are still being undertaken have tended to focus on these economies rather than in New Zealand," the article said.

During the crisis, liquidity in the NZ dollar market became very thin, which caused a sharp widening in the spread between the bid and offer, or buy and sell, quotes.

While the bid-offer spread has narrowed again, the spread remains slightly elevated compared to post-crisis levels and the NZ dollar spread remains above those in other major currencies.

"In an environment of increased volatility, this may remain a disincentive for some investors trading NZ dollar," the article said.

Separately, Treasury published a working paper which seeks to understand the extent of fluctuations in the NZ dollar compared to other currencies.

The paper finds that New Zealand's exchange rate fluctuates greatly but that Australia and Japan also face the high levels of short-term volatility.

- NZPA