Dollar Regains Appeal in Carry Trades
29 September 2020 - 10:26AM
Dow Jones News
By Caitlin Ostroff
This year's decline in the U.S. dollar is drawing investors back
into a practice that they had eschewed for some years: Borrowing
the greenback to buy riskier assets in what is known as a carry
trade.
A number of investors are pursuing higher returns by buying
overseas assets. Investment firm Ashmore Group, for instance, sold
the dollar to add local-currency government bonds from Mexico,
Indonesia and Brazil to its portfolios, according to Jan Dehn, head
of research.
The dollar is being used to fund such trades after a drop in
U.S. interest rates this year made it less attractive for investors
to hold dollar-denominated assets. With the Fed pledging to keep
U.S. rates near zero for the foreseeable future, it may stay that
way for a while.
The Fed's purchases of corporate and government bonds has also
sent yields tumbling. Treasurys lost much of their allure as a
store of value when real yields dropped into negative territory
with the expected rate of inflation climbing. That has left
investors facing the prospect of losing money if they hold
government bonds until maturity.
Investors are now turning to bonds outside the U.S. that offer
positive yields when adjusted for inflation.
Mr. Dehn expects the dollar to weaken in the coming years
because the economic recovery is likely to be faster outside the
U.S. He is not alone. Speculative bets that the currencies of the
Group of 10 leading industrial countries will appreciate against
the dollar are at a two-year high, according to data compiled by
RBC Capital Markets.
The ICE U.S. Dollar Index, which tracks the greenback against a
basket of currencies, has already fallen 2.3% this year, putting it
on track for its worst performance in three years.
A weaker dollar would help the U.S. economic recovery, said Jane
Foley, head of foreign-exchange strategy at Rabobank, even though
the U.S. imports more than it exports. It would make U.S. exports
cheaper for buyers, increasing the competitiveness of U.S. goods
and helping offset the pain of a higher import bill, she said.
The growing use of the dollar in funding carry trades marks a
shift in attitude among investors, who for some years have favored
the Japanese yen over most other currencies. The euro also grew
popular over the last couple of years with the European Central
Bank taking its policy rates into sub-zero territory. Negative
interest rates mean investors get paid to borrow money.
In contrast, the dollar grew less attractive as a funding
currency between 2015 and 2017, when the Fed increased interest
rates. This year, the difference between interest rates in the
eurozone and the U.S. has shrunk.
For carry trades, investors look for currencies that are not
just backed by low interest rates, but are also likely to be stable
or to weaken. This can increase their profit when the trade is
closed.
Vasileios Gkionakis, head of foreign-exchange strategy at Swiss
private bank Lombard Odier, thinks the dollar is still overvalued
by 10%-15% and is betting on a further decline over the coming
year. He plans to use the greenback as a funding currency to bet on
the strengthening of emerging market currencies in Asia, including
the Chinese yuan, the South Korean won and the New Taiwan
dollar.
Stuart Edwards, a U.K.-based fund manager at Invesco, also
expects the dollar to weaken, particularly given the Fed's recent
guidance on rates. "It's very difficult to bet against the central
banks," he said.
Mr. Edwards has used the dollar to buy Mexican peso-denominated
government bonds. The peso has gained 13.1% from its March lows,
and offers a return of about 2.25% over the next year, according to
Goldman Sachs.
But not all investors are convinced that the dollar will
continue weakening. Some are betting that it will strengthen, given
the possibility of a close U.S. presidential election and higher
Covid-19 infection rates during the winter.
If the dollar strengthens, that could cause investors to close
their positions and buy back the dollar, adding to the greenback's
strength. Just last week, the ICE U.S. Dollar Index rose 1.9% amid
concerns about the economy's uneven pace of recovery.
Another stock market rout this year could help the dollar
strengthen, said Zach Pandl, co-head of global foreign exchange,
interest rates and emerging markets strategy research at Goldman
Sachs.
"If the global economy were back in recession, that would tend
to be positive for the dollar," said Mr. Pandl. "The dollar is
still a safe haven asset, and when we see large equity drawdowns,
the dollar tends to appreciate."
Write to Caitlin Ostroff at caitlin.ostroff@wsj.com
(END) Dow Jones Newswires
September 29, 2020 05:11 ET (09:11 GMT)
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