Analysis: Asia FX carry trade returns but hostage to volatility

Thu Dec 12, 2013 8:05pm EST
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By Vidya Ranganathan

SINGAPORE (Reuters) - The currency carry trade is making a slow comeback in Asia although, unlike its popular pre-crisis version, punters are more selective in their investment targets for fear that market volatility could leave them with losses.

This time, carry traders are eschewing traditional high-yielding currencies such as the Australian dollar, Indian rupee and Indonesian rupiah in favor of the stability of the Singapore dollar and Chinese yuan.

The most speculative short positions in the yen since 2007 and a rising Singapore dollar provide hints that this form of currency trading is returning.

The carry trade involves investors selling short one currency and buying assets in another currency to lock in the yield differential, or 'carry'.

The trade was widespread before the global financial crisis as investors sold the low-yielding yen to invest in higher yielding currencies. Money flooded into New Zealand's dollar, raising concerns among policymakers at the time that it could destabilize the small economy.

"It's structurally different now compared to what it was pre-2007," said Geoff Kendrick, head of emerging markets FX strategy at Morgan Stanley in Hong Kong.

"Then you had investors reach for yield, which resulted in large carry positions in FX. It was at that stage much more of a buy-and-close-your-eyes kind of trade."

Now investors are wary of volatility, Kendrick said, citing the rupee, which slumped to a record low against the dollar this year. "It has a very strong carry and yet the market is being much more nuanced," he said.   Continued...

A pedestrian is reflected in an electronic board showing exchange rates between the Japanese yen against the euro (top L to bottom), the yen against Australian dollar, as well as indices for the Dow Jones industrial average and the Nasdaq outside a brokerage in Tokyo December 10, 2013. REUTERS/Yuya Shino