Worst carry trades show central banks reach stimulus limits

The $4 trillion-a-day foreign-exchange market is losing confidence in central banks’ abilities to boost a struggling world economy.

Rather than sparking bets on growth, the JPMorgan Chase & Co. G7 Volatility Index, which doubled in 2008 before policy makers employed extraordinary measures to address faltering global expansion, has dropped to a five-year low. While small foreign-exchange swings historically favor the strategy of borrowing in low-yielding currencies to buy those with higher returns, a UBS AG index that tracks profits from the so-called carry trade has fallen to the lowest level since 2011.

“At this stage it may feel frustrating, but waiting is not a bad strategy,” Mauricio Bouabci, a London-based currency fund manager at Pareto Investment Management Ltd., which oversees $45 billion, said in an Oct. 17 telephone interview. It would take increased volatility to tempt him back into the market, he said.

Foreign-exchange speculation is declining as mandated spending cuts and tax increases in the U.S. next year, concern that European government leaders aren’t moving fast enough to fix the region’s debt crisis, and slowing growth in emerging economies from China to Brazil weigh on sentiment. The world economy will expand 3.3 percent this year, the least since the 2009 recession, the International Monetary Fund said on Oct. 9.

Dwindling Volume

Average daily volume in foreign exchange fell 39 percent in September from a year earlier, according to data from ICAP Plc’s EBS trading platform. That’s also harming currency managers’ efforts to boost returns.

The UBS V24 Carry Index surged 4.55 percent in the first quarter, the most since 2009, amid optimism the economic recovery was gathering pace. It ended last week at 428.71, down 7 percent from this year’s high of 461.01 set on Feb. 29.

The gauge has fallen 4.8 percent from a level of 450.15 on Aug. 9, before the Federal Reserve said it would buy $40 billion of mortgage debt a month until it sees improvement in the U.S. economy, the European Central Bank said it would buy bonds of indebted members that ask for aid and the Bank of Japan boosted its asset-purchase fund to 55 trillion yen ($690 billion). The JPMorgan volatility index fell to 7.47 percent on Oct. 15, the least since October 2007.

“Low volatility is something that participants haven’t felt comfortable with for a while,” Adrian McGowan, head of foreign-exchange forwards, options and trading in Europe at Barclays Plc in London, said in an Oct. 12 interview. Investors haven’t been making “large” bets “because there has been so much uncertainty,” he said.

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