New York May 29 2024: Exploiting differences in interest rates is set to become one of the most popular investment strategies in coming months as markets bet shallower cuts will keep volatility subdued.
Strategists across Wall Street are touting carry trades, which harvest the extra income on higher-yielding currencies and bonds, and thrive in calm markets when there’s a lower risk of wild price swings wiping out profits.
UBS Group AG recommends selling the Swiss franc to buy US and Australian dollars, Societe Generale SA likes riskier European government bonds, and Pictet Asset Management is locking in high yields with local-currency bonds from Mexico and Brazil.
Carry has gained traction since Federal Reserve Chair Jerome Powell effectively ruled out further rate hikes. That removed a potential volatility trigger and set the scene for cautious easing alongside major peers like the European Central Bank and Bank of England. Traders will be watching Friday’s Commodity Futures Trading Commission data for signs money is following Wall Street’s calls.
“The Fed’s signaling of no further hikes is a green light for carry trades in fixed income and elsewhere,” Bank of America strategists including Ralph Axel wrote in a note this week. Subdued volatility “should support a wide range of carry trades over the summer,” they said.
The carry trade has already had a strong start to the year in the main developed currency markets. A Bloomberg index based on selling the lowest-yielding G10 currencies to buy the highest yielders has had a nearly 7% return so far this year, the best performance by this point in the year since 2009.
Those returns should keep coming: inflation is still sticky and resurgent growth limits how far policymakers can cut, which keeps a lid on market volatility.
Carry trades are being put on “everywhere” as investors prepare for this quiet period, according to Peter Schaffrik, global macro strategist at RBC Capital Markets. The MOVE index, a gauge of future rates market volatility, has declined to its lowest since early 2022.
UBS strategists including Shahab Jalinoos favor using the Swiss franc to buy US and Australian dollars.
They say the case to use the franc as the funding currency is boosted by the prospect of larger rate cuts than the market is pricing, putting it “uniquely at risk.” In contrast, the Aussie dollar looks appealing given sticky inflation and an upcoming fiscal boost, “raising the odds” that it gets “sustained rate support,” they said.
The CFTC data on Friday will be scrutinized for growing signs that investors are shorting certain currencies to fund their carry trades — or signals that there are increased long positions in the higher yielders.
Societe Generale and JPMorgan Chase & Co. suggest bond investors position for the higher income offered by riskier government debt such as Italy’s over core nations like Germany.
Carry Heartland
And in the traditional carry-trade heartland — emerging markets — the strategy is making a comeback. A gauge of interest-rate arbitrage in developing-nation currencies is poised for the biggest monthly gain since November, with twenty of the 21 most widely used emerging market currencies producing a positive return in May.
The Chilean peso is leading as it rallies on higher copper prices. The Turkish lira and the Mexican peso are also contributing as they benefit from interest-rate hikes and a cautious central bank, respectively.
It’s a turnaround from the first four months of the year when dollar-funded developing-nation carry trades saw the worst start to a year since 2020.
Andres Sanchez Balcazar, head of global bonds at Pictet Asset Management, said he’s buying local-currency bonds in Mexico and Brazil to ensure returns on his portfolios beat cash. He’s also been buying ultra short-dated, dollar-denominated debt from African countries including Angola, Ghana and Zambia.
“Curves are inverted, spreads are tight, so this is probably not the time to take a lot of risk,” he said in an interview. “If anything, this is the time to make sure that you have enough carry in your portfolio to beat the cash rate.”
