Worst carry trades show central banks reach stimulus limits

Smaller Margin

“There are still carry opportunities, but they are not as big as they used to be so your margin of error to get in is smaller,” Brian Kim, a currency strategist at Royal Bank of Scotland Group Plc’s RBS Securities Inc. in Stamford Connecticut, said in an Oct. 17 telephone interview.

The Bloomberg-JPMorgan Asia Dollar Index has climbed 2 percent this year, while the Mexican peso strengthened more than 8 percent against its U.S. counterpart.

Doubts about the strength of the global economy flared on Oct. 19. U.S. stocks slid the most since June as companies from General Electric Co. to McDonald’s Corp. and Microsoft Corp. posted earnings below analyst estimates and euro-area leaders failed to discuss aid for Spain at a summit.

China Investment

Earlier in the day, China’s Ministry of Commerce said foreign direct investment in the world’s second-biggest economy, fell 6.8 percent in September from a year earlier to $8.43 billion. China’s economy expanded 7.4 percent in the third quarter, the weakest pace in more than three years.

In reducing its forecasts for 2012 and 2013, the Washington-based IMF said it now sees “alarmingly high” risks of a steeper global economic slowdown, with a one-in-six chance of growth slipping below 2 percent.

At the same time, the U.S. faces $600 billion in automatic spending cuts and tax increases starting Jan. 1 if Congress can’t agree on ways to reduce the deficit. Economic output would shrink by 0.5 percent next year, and joblessness climb to about 9 percent if the so-called fiscal cliff isn’t averted, according to the Congressional Budget Office.

Policy makers from Australia to Sweden, who had kept interest rates high as their economies grew, are lowering borrowing costs, reducing the allure of carry trades.

Rate Cuts

Australia’s central bank cut rates five times in the past 12 months. The Aussie’s appeal to global investors has flagged, falling 3 percent to $1.0311 since mid-September, as the spread between 10-year Australian and U.S. Treasury yields narrowed to 1.42 percentage points on Oct. 19 from 2.32 percentage points a year earlier.

Rates may be cut further, according to the minutes of a Reserve Bank of Australia meeting on Oct. 2. Sweden’s Riksbank lowered borrowing costs in September, predicting growth will slow to 1.5 percent this year from 3.9 percent in 2011.

Hedge funds focused on foreign-exchange trading have lost 0.6 percent in the past three months, according to industry researcher HedgeFund.net. That compares to an average gain of 1.9 percent since June for the industry.

Trading ranges for currencies have narrowed across major pairs. The average daily percentage change of the Australian dollar versus its U.S. counterpart has declined to 0.47 percent in 2012 from 0.68 percent last year, while for the real it has shrunk to 0.51 percent from 0.72 percent.

“We are likely to stay in an environment of low rates for longer,” Morgan Stanley currency strategists led by Hans Redeker in London wrote in an Oct. 18 research report. In such an environment, potential returns from carry trades are “likely to be limited,” they wrote.

Bloomberg News

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