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Surging Volatility Turns Currency Trade Darling Into Loser

Susanne Barton and Robert Fullem
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Surging Volatility Turns Currency Trade Darling Into Loser

(Bloomberg) -- The highest volatility in a decade has trounced carry traders and is pushing a momentum-based approach to the fore.

Amid the coronavirus shock, an oil-price war and turmoil in equities, turbulence in Japan’s currency reached levels unseen since 2008 this week. There’s little doubt about what’s worked for investors this year: The trend-following strategy is up 9.5%, while carry trades have lost 7.4%, according to Deutsche Bank AG data. It’s a stark turnaround for carry, which thrives in periods of calm and delivered the best returns in 2019.

Demand for havens has driven the reversal in the $6.6 trillion-a-day market. In the past few weeks, investors have exited riskier, higher-yielding currencies and piled into the yen, a favored oasis for investors in times of stress. For traders, spiking volatility and questions about how policy makers will try to stabilize the economic outlook suggest momentum will continue to rule for the time being.

“The carry trade is lost in the uncertainty surrounding the virus, collapse in oil prices and global growth,” said Paresh Upadhyaya, a portfolio manager at Amundi Pioneer Asset Management. “It could be some time before it comes back.”

To illustrate the volatility: The yen soared to a more than three-year high of 101.19 per dollar Monday. It then slumped the most since 2013 Tuesday amid expectations of fiscal stimulus from the Trump administration. It was surging again Wednesday, gaining 0.8% to 104.82 per dollar as stocks again looked shaky.

The wild swings have raised speculation that the Japanese government may consider intervening in the market for the first time since 2011.

2020 Turnaround

In the carry trade, investors borrow in low-yielding currencies such as the yen or euro and use the proceeds to buy bonds or other assets where rates are higher. It returned 2.9% in 2019, outpacing strategies that depend on momentum and value, Deutsche Bank data show.

Last year, the carry approach dominated in part because FX markets were calmer than ever. At year-end, one-month dollar-yen implied volatility reached an unprecedented low. It started to surge in January as doubts about the economic outlook grew with the spread of the coronavirus.

The strategy has also suffered from declining liquidity in currencies amid the market turmoil.

Carry has been the “stark underperformer” as thinner liquidity means “position unwinds have been able to impact price action to a greater degree,” Meera Chandan, a strategist at JPMorgan Chase & Co., wrote in a note to clients emailed Tuesday.

(Updates prices in third and fourth paragraph under the first chart.)

--With assistance from Masaki Kondo.

To contact the reporters on this story: Susanne Barton in New York at swalker33@bloomberg.net;Robert Fullem in New York at rfullem5@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Emily Barrett

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