Worst carry trades show central banks reach stimulus limits

Real Weakness

The dollar fell 0.6 percent against the euro last week to $1.3024, and rose 1.1 percent to 79.32 yen as speculation the Bank of Japan will boost monetary stimulus sapped demand for that nation’s assets. The U.S. currency fell 0.3 percent to $1.3061 per euro and gained 0.6 percent to 79.83 yen as of 12:47 p.m. in New York.

Investing the proceeds of dollar-denominated loans should offer easy profits because the Fed has said it’s likely to keep the target rate for overnight lending between banks near zero through mid-2015. The carry trade can lose money when the currency used to fund the strategy strengthens, or the targeted currency weakens, or some combination.

Selling borrowed dollars to buy reais in Brazil, where the target interest rate is 7.25 percent, has lost about 3.4 percent this year as the real tumbled, according to data compiled by Bloomberg. The IMF says Brazil will grow 1.5 percent this year, instead of the 2.5 percent predicted in July.

Implied Volatility

Borrowing euros and using the proceeds to buy the New Zealand dollar, where the official cash rate is 2.50 percent, produced an 8.2 percent loss since Sept. 6, when the ECB’s pledge to offer Spain assistance helped trigger a slump in three-month implied volatility for the pair.

“Carry had such beautiful, fantastic returns -- so alluring, so attractive that I think people got hooked on it like a drug,” David Bloom, global head of currency strategy at HSBC Holdings Plc in London, said in a telephone interview on Oct. 19. “In today’s zero interest-rate policy world, peppered with unconventional policies, it is much more difficult and confusing,” he wrote in an Oct. 12 research report.

Signs of strength in the global economy have emerged, including gains in jobs, consumer confidence and retail sales in the U.S., the world’s largest economy.

The Citigroup Economic Surprise Index for the Group-of-10 countries, which measures when data is beating or trailing the forecasts of analysts, climbed to a seven-month high of 18.4 last week, from this year’s low of minus 56.2 on June 26. The MSCI All-Countries World Index of shares has jumped 15 percent from this year’s low in June.

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