KEY POINTS:
At a time when interest rates are sinking towards zero around the world, the biggest currency traders are recommending countries that have the largest trade surpluses, led by Japan, Norway and Switzerland.
BNP Paribas SA, the best currency forecaster in a 2007 Bloomberg survey, says the yen will strengthen about 14 per cent against the dollar by June.
Goldman Sachs made Norway's krone one of its top picks for the year, with possible gains of 17 per cent versus the dollar.
Bank of America, the largest United States lender by assets, says the Swiss franc will advance against every major currency.
The global economic crisis that forced central banks from the US to New Zealand to cut interest rates last year also reduced earnings from so-called carry trades by about half, data compiled by Bloomberg showed.
Currencies of countries with trade surpluses are perceived as safer because governments don't have to brave credit markets in a year when sovereign bond sales are likely to exceed US$3 trillion.
"The tide has turned," said Jens Nordvig, a senior currency strategist in New York at Goldman Sachs. "Surplus currencies such as the franc and the yen are likely to perform well, while the deficit countries are pretty vulnerable."
Switzerland's current-account surplus was 8 per cent of gross domestic product last year, Japan's was 3.8 per cent and Norway's 16 per cent, the Organisation for Economic Co-operation and Development said.
That compares with deficits of 4.9 per cent of GDP in the US, 5.1 per cent in Australia and 9.5 per cent in New Zealand.
Buying the currencies of nations with the six largest trade surpluses and selling those with deficits returned 4 per cent this month, the most since October, according to Goldman Sachs' CA Outperformance index.
The same wager would have lost 5.9 per cent in the six months through September, the index shows.
Carry trades - where investors seek profits buying higher-yielding assets with money borrowed from low interest-rate countries - were the mainstay of the foreign-exchange market for six years until investors started unwinding the strategies last year after central banks reduced borrowing costs as a global recession began.
The best carry trade within the Group of 10 economies is the 4.90 percentage-point difference between Japan's 0.10 per cent key rate and the 5 per cent rate set by the Reserve Bank of New Zealand.
A year ago, the spread between the two rates was 7.75 percentage points.
Carry trades became less popular last year as volatility grew, increasing the risks that profits would be wiped out by sudden changes in exchange rates.
Fluctuations among major currencies doubled to 19 per cent since the end of 2007, data compiled by JPMorgan Chase showed. In emerging markets, they tripled to 24 per cent.
"Markets tend to pay more attention to fundamental valuations in times of high volatility and uncertainty," said Henrik Gullberg, a strategist in London at Deutsche Bank AG, the world's biggest foreign-exchange trader.
The current account, the broadest measure of trade, "goes into any fundamental valuation of a currency".
The Australian dollar weakened 4.2 per cent against the US dollar this year, after a 20 per cent slide last year.
The yen is little changed, after appreciating 23 per cent. The Swiss franc declined 5.4 per cent against the dollar this year, compared with a 6.1 per cent advance last year.
"Switzerland has a double-digit current-account surplus in a world where interest-rate differentials are less important," said David Powell, a currency analyst in London at Bank of America. "The franc will rally across the board."
The Swiss franc will rise 1 per cent this year, according to the median of 34 estimates compiled by Bloomberg. The yen will end the year 8.2 per cent weaker and the krone will advance 5.9 per cent, separate surveys show.
The Australian and New Zealand dollars will be little changed, Bloomberg surveys show.
Volatility increased because investors fled to the perceived safety of dollars as credit markets seized up after the collapse of Lehman Brothers in September and the US, Japan and Europe slid into recessions.
Banks posted more than US$1 trillion in writedowns and losses since the start of 2007.
In the past month, a basket of high-yielding currencies including the Norwegian krone, the euro and the Australian and New Zealand dollars would have lost 14 per cent against the yen on an annualised basis, according to data compiled by Bloomberg.
The same wager lost 31 per cent last year and gained 8.7 per cent in 2007.
Between 2002 and 2008, currencies of countries with current-account surpluses lagged behind those with deficits.
Goldman Sachs' CA Outperformance index declined 40 per cent in the five years through October 2007.
Betting on gains in so-called surplus currencies ignores the risk that global trade will nosedive, said Chirag Gandhi, a money manager of a US$2.5 billion fund at the Investment Board of State of Wisconsin in Madison, Wisconsin, who cut his bets on gains in the yen.
International trade will shrink this year for the first time in more than 25 years, the World Bank said last month.
The record US$6 billion in bets that hedge funds and large speculators put on a yen rally created a "crowded trade", Merrill Lynch said in a January 6 report, citing Commodity Futures Trading Commission data.
The yen strengthened 14 per cent against the euro in the past three months and 12 per cent versus the dollar.
There's also the risk that central banks will take steps to prevent their currencies from strengthening.
Japan Finance Minister Shoichi Nakagawa signalled last month that policy-makers were ready to intervene in the foreign exchange market for the first time in four years.
Thomas Jordan of the Swiss National Bank said last week the central bank was watching foreign exchange markets "very closely".
As investor appetite for risk returns "to more normal levels, you'll see yen selling", said Steven Englander, a currency strategist at Barclays Capital in New York.
"You want to be prepared for the market sentiment to turn around."
Economies around the world are showing few signs of a rebound. Barclays predicts global economic growth of 0.8 per cent this year, the slowest pace in more than half a century.
Buying currencies with surpluses "will gain more credibility as interest rates narrow", said Paresh Upadhyaya, who helps manage US$50 billion in currency assets as a Putnam Investments senior vice-president in Boston. "Relative economic performance will become important."
Investors should buy the yen against the British pound, the Australian dollar and eastern European currencies such as the Hungarian forint and Polish zloty, Upadhyaya said.
The Reserve Bank of Australia reduced its main interest rate to 4.25 per cent from 7.25 per cent in August.
The Bank of England cut borrowing costs to 1.5 per cent from 5 per cent in the period.
Countries with trade deficits are preparing to borrow record sums to finance economic-stimulus programmes.
Euro-region nations will borrow about US$1.1 trillion this year, according to Royal Bank of Scotland.
The US Treasury will borrow about US$2 trillion this fiscal year ending September 30, compared with $892 billion in notes and bonds last year.
"It's about preservation of capital rather than return on capital," said Scott Ainsbury, who helps manage about US$12 billion in currency in New York at FX Concepts and is buying the franc and the yen while selling the New Zealand dollar.
"People who say the bottom is in are kidding themselves. What you see is people basically running away from risk."
- BLOOMBERG
