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Borrow near zero, invest abroad: The ‘carry trade’ is back

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Another sign of the return of risk-takers to world financial markets: the revival of the so-called carry trade.

The carry strategy simply involves borrowing in countries with low interest rates to invest in countries with higher rates. The investor hopes to profit from the difference between the loan rate and the rate earned in the target country.

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Bloomberg News reports:

Stimulus plans and near-zero interest rates in developed economies are boosting investor confidence in emerging markets and commodity-rich nations with interest rates as much as 12.9 percentage points higher. Using dollars, euros and yen to buy the currencies of Brazil, Hungary, Indonesia, South Africa, New Zealand and Australia earned 8% from March 20 to April 10, that trade’s biggest three-week gain since at least 1999, data compiled by Bloomberg show. Goldman Sachs Group, Insight Investment Management and Fischer Francis Trees & Watts have begun recommending carry trades, which lost favor last year as the worst financial crisis since the Great Depression drove investors to the relative safety of U.S. Treasuries. Now efforts to end the first global recession since World War II are sending money into stocks, emerging markets and commodities.

A straightforward carry-trade transaction, Bloomberg notes, would be to borrow U.S. dollars at the three-month London interbank offered rate of 1.13% and use the proceeds to buy Brazilian real and earn Brazil’s three-month deposit rate of 10.51%. That would net an annualized 9.38% -- as long as both currencies remain stable.

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That’s one of the big risks: The carry trade works as long as emerging-market currencies stay relatively stable or appreciate. If they plunge against the dollar and other developed currencies the assets bought by carry-trade investors also will be devalued, leading to potentially heavy losses. Of course, many individual investors are profiting from the comeback of emerging markets by investing directly in mutual funds that own stocks or bonds in those markets. The iShares MSCI Emerging Markets Stock Index exchange-traded fund surged from about $20 a share in early March to $28.12 as of Monday, a gain of 41%.

But hedge funds and other big investors are looking for juicier results. Bloomberg notes:

Goldman Sachs recommended on April 3 that investors use euros, dollars and yen to buy Mexican pesos, real, rupiah, rand and rubles from Russia, where the benchmark central bank rate is 13%. Using equally weighted baskets, that carry trade would have returned 8% in the past month, for an annualized 165%, data compiled by Bloomberg show. “The downside risks have declined significantly for emerging-market currencies,’ said Themos Fiotakis, a London-based Goldman analyst. ‘Even if these currencies remain flat, the carry is still attractive.”

-- Tom Petruno

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