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Euro Lures Carry Trade Kudos in Worst Year Since ’05: Currencies

The euro is gaining favor among the world’s biggest foreign-exchange dealers for use in funding carry trades, heaping additional pressure on the 18-nation currency as it wraps up its worst year in almost a decade.

Citigroup Inc. and Barclays Plc both say traders should borrow euros to finance the purchase of currencies in nations with relatively higher interest rates. Such a strategy would generate profits against 29 major currencies by mid-2015, up from 12 at the end of June, data compiled by Bloomberg showed as of yesterday.

Europe’s common currency may usurp the yen as the funding currency of choice amid speculation the European Central Bank will debase the euro by expanding the money supply through bond purchases. That may boost the potential return from carry trades, which benefit when the funding currency depreciates.

“There’s more that could come out of the ECB in terms of upside surprises than the Bank of Japan,” said Paresh Upadhyaya, the Boston-based director of currency strategy at Pioneer Investment Management Inc., which oversees about $ 250 billion. “We have a bigger short-euro position than we have a short-yen position,” he said, referring to bets the currencies will weaken against others.

Volatility ‘Spikes’

Investors such as Upadhyaya say they’re less confident Japan will unveil further easing, even after Prime Minister Shinzo Abe’s re-election this week strengthened his hand to extend stimulus measures.

After gaining in the first two quarters of the year, carry trades have hurt investors amid a jump in volatility and a collapse in emerging-market currencies. The Deutsche Bank Currency Harvest Global index has fallen 3.7 percent since June 30, following a jump of 2.3 percent in the first six months.

The yen’s wider and faster price swings may eat into carry returns. Three-month implied volatility on the yen has increased to more than 2 percentage points above that on the euro, more than this year’s 1.5 percentage-point average.

“Your ideal candidate for the funding currency should be as stable as possible, and more recently we’ve seen spikes in yen volatility,” Upadhyaya said by phone on Dec. 10.

Pioneer has bought Poland’s zloty and India’s rupee with euro fundings, he said.

QE Confidence

Returns from the euro will be roughly in line with gains of deals using the yen. In 2013, the yen made money against all 31 major currencies, compared with just five for the euro.

That’s changing on speculation the ECB is getting closer to embarking on purchases of sovereign bonds, or quantitative easing. The BOJ already buys government debt, limiting its room for further expansion.

Carry trades are best done “against the euro right now” because while QE from the ECB is anticipated, it’s “not fully priced in,” Steven Englander, the head of Group-of-10 currency strategy at Citigroup, said in an interview in New York on Dec. 10. “Over the next two to three months, whatever surprises that are left in QE will come out, more than anything from Japan.”

Declines in the euro may be tempered by the record 30 billion-euro ($ 37.4 billion) surplus in the region’s current account, the broadest measure of trade. Japan has had 28 straight months of trade deficits.

‘Structural Support’

“There’s a lot of structural support there for the yen,” Peter Dragicevich, a strategist at Commonwealth Bank of Australia, said by phone from London on Dec. 12. “Compared to the euro, from that perspective, the yen is still the preferred option.”

Barclays, the third-biggest currency dealer, recommends selling the euro to buy Indonesia’s rupiah, India’s rupee and Brazil’s real, which all have central bank rates of at least 7 percent. (IDBIRATE) The ECB lowered its benchmark to a record 0.05 percent and introduced a negative deposit rate this year, while Japan’s main rate has been close to zero for almost a decade.

The euro has weakened 9.4 percent versus the dollar in 2014, reaching a more-than two-year low of $ 1.2247 on Dec. 8, while the yen touched the weakest in seven years the same day. Both currencies will slide more than 3 percent by next June, according to median forecasts compiled by Bloomberg.

The euro traded at $ 1.2459 as of 1:12 p.m. today in Tokyo and the yen was at 117.39 per dollar.

“With QE in place, the euro would become probably the funding currency of choice,” Neil Mellor, a currency strategist at Bank of New York Mellon in London, said by phone on Dec. 9. “Expectations of it going below $ 1.20 would be solidified.”

To contact the reporters on this story: David Goodman in London at [email protected]; Andrea Wong in New York at [email protected]

To contact the editors responsible for this story: Paul Dobson at [email protected] Paul Armstrong, Greg Storey

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