the developments in currency markets as a result of moves by major central banks towards quantitative easing

TO BE NOTED: From the FT:

"Carry trade makes a comeback

By Peter Garnham

Published: March 27 2009 15:50 | Last updated: March 27 2009 15:50

A rebound in global equity markets appears to have prompted the return of a familiar investment theme: the carry trade.

The strategy, which involves selling lower-yielding currencies, such as the yen, to fund the purchase of higher-yielding assets elsewhere, was popular among investors ahead of the financial crisis.

The strategy rests not just on interest differentials, but also on stability in asset markets since a sharp fall in the value of an investor’s target investment can wipe out any yield advantage of funding through a low-yielding currency.

Indeed, the turmoil on financial markets saw investors scramble to unwind carry trades as asset prices plunged. This deleveraging sent the yen sharply higher.

Against the dollar, the yen has risen 8 per cent since the collapse of Lehman Brothers in mid-September last year.

It’s rise against the higher-yielding New Zealand and Australian dollars has been more acute, rising 18 per cent and over 28 per cent respectively. But analysts say the rally in global equities has paved the way for investors to return to the carry trade.

Since hitting a 13-year low on March 6, the benchmark S&P 500 index of US stocks has notched up three straight weeks of gains, helped by the aggressive fiscal and monetary policy stance of the US authorities.

Some investors believe that the equity market sell-off has run its course.

Larry Kantor, head of research at Barclays Capital, says after the rally in markets over the past few weeks, the question foremost in the minds of investors is whether it is sustainable or yet another false start.

“We believe that the latest rally will have stronger legs, and thus marks an inflection point,” he says. “We are now recommending that investors become more aggressive and take risks across a broader range of assets.”

Hans Redeker, at BNP Paribas, says the performance of equities are important for carry trade investors.

First, reduced asset volatility allows investors to increase the size of positioning which is important for the asset side of carry trades. Second, rising asset prices will reduce deleveraging pressure.

“Deleveraging pushed the yen lower in the autumn and winter, but those days are gone,” said Mr Redeker. “Financial markets look brighter.”

Indeed, the New Zealand dollar and the Australian dollar, the two major target currencies for carry trade investors ahead of the financial crisis have performed strongly so far this month.

Buoyed also by a rally in commodity prices, the New Zealand dollar is up 14 per cent against the yen and 14 per cent stronger against the dollar since the start of the month, while the Australian dollar has climbed 8 per cent against the yen and gained 8.4 per cent against the dollar.

Mr Redeker believes there could be more gains in store, especially for the New Zealand dollar, the favourite currency of Japanese margin traders.

Rising Japanese shares are likely to increase the risk appetite of Japanese retail investors, encouraging them to send funds abroad in search of yield. “Japanese margin accounts are heavily long on the yen and when this position is reversed the New Zealand dollar will benefit most,“ says Mr Redeker.

Steve Barrow, at Standard Bank, prefers to see the developments in currency markets as a result of moves by major central banks towards quantitative easing.

He says one thing noticeable from currency movements is that the “periphery” currencies, such as the Australian dollar, New Zealand dollar, Norwegian krone and Swedish krona, have out-performed the core – or G7 – currencies.

Indeed, since the start of the month, the Norwegian krone is up 9 per against the dollar and the Swedish krona has gained 13 per cent.

All four of those countries, unlike other major economies are expected to avoid debasing their currencies by moving towards quantitative easing.

“We could, of course, throw in emerging market currencies as well although we feel they are a little more dependent on a persistence of recent stock market strength, which leaves us a little uncomfortable,” says Mr Barrow.

He says if currency investors can ride through any temporary stock market setbacks, the best returns are to be had in these periphery countries unless, they too, take the quantitative easing bait."