London - There’s life in the
great emerging-market carry trade yet, although now it comes with a twist.
Investors are betting a
trade that reaped returns of more than 20 percent last year for borrowing
dollars to buy Brazil’s real, Russia’s ruble and South Africa’s rand has
further to run - only they’re using the battered British pound to fund long
positions in emerging-market currencies. Citigroup on Monday named shorting the
pound against the Russian ruble its top trade of the week.
The so-called carry trade,
in which investors borrow in countries with low rates to invest in
higher-yielding assets, lost some of its appeal late last year as rising US
borrowing costs bolstered the greenback and Donald Trump’s election damped
appetite for risk. Now the pound’s volatility, sparked by the UK’s move to pull
out of the single European market, is making developing markets look like a
relatively safe bet.
“Sterling is as volatile as any
emerging-market currency at the moment,” said Ben Kumar, the London-based investment
manager at Seven Investment Management, which oversees about 10 billion pounds
($12 billion) and is adding to holdings in emerging-market local-currency
bonds. “The currency risk is much easier to take than emerging-market
currencies versus the dollar.”
The pound’s wild swings have
closely tracked every new piece of information on the British government’s
Brexit plans. The currency plunged more than 1 percent on Monday, then surged
more than 3 percent on Tuesday after Prime Minister Theresa May said UK
lawmakers will get a vote on the final deal for the nation’s exit from the
European Union. A measure of the pound’s price swings against the dollar
in the past week climbed to 23.3 percent on Tuesday, the most among 16 major
developed-nation and emerging-market currencies. One-month implied volatility,
based on prices of options to buy or sell the pound against the dollar and seen
as a gauge of trader’s expectations for future gyrations, climbed to a
three-month high.
High rates
Many emerging-market countries
offer attractive carry-trade opportunities because they were forced to push up
interest rates during the 2015 commodity crash. South Africa’s central bank lifted
its policy rate four times in the past two years to 7 percent, where it will
remain in 2017, according to a Bloomberg survey of economists. Russia’s
benchmark rate will stay above 8 percent, the survey shows.
Those relatively high rates,
together with currency gains against the dollar, garnered carry returns of 32
percent for the ruble and 21 percent for the rand in 2016. Using the pound as a
funding currency, returns in the first two weeks of this year were 4.2 percent
for the ruble and 2.5 percent for the rand.
In Russia “we expect the
significant real rate levels to persist for a period of time given the central
bank’s focus on engineering a reduction in inflation expectations,” bolstering
the pound-ruble carry trade, analysts at Citibank including Luis Costa said.
-With assistance from Constantine Courcoulas, Ed
Ludlow and Stefania Spezzati.
BLOOMBERG