Carry Trades Show Limit to Central Bank Stimulus

FX volatility hits five-year low; carry trade profitability has declined.

The $4 trillion-a-day foreign-exchange market is losing confidence in central banks’ abilities to boost a struggling world economy.

Rather than sparking bets on growth, the JPMorgan Chase & Co. G7 Volatility Index, which more than doubled in 2007 to 2008 before policy makers employed extraordinary measures to address faltering global expansion, has dropped to a five-year low. While small foreign-exchange swings historically favor the strategy of borrowing in low-yielding currencies to buy those with higher returns, a UBS AG index that tracks profits from the so-called carry trade has fallen to the lowest level since 2011.

Real Weakness

The dollar fell 0.6 percent against the euro last week to $1.3024, and rose 1.1 percent to 79.32 yen as speculation the Bank of Japan will boost monetary stimulus sapped demand for that nation’s assets..

Smaller Margin

“There are still carry opportunities, but they are not as big as they used to be so your margin of error to get in is smaller,” Brian Kim, a currency strategist at Royal Bank of Scotland Group Plc’s RBS Securities Inc. in Stamford Connecticut, said in an Oct. 17 telephone interview.

Rate Cuts

Australia’s central bank cut rates five times in the past 12 months. The Aussie’s appeal to global investors has flagged, falling 3 percent to $1.0311 since mid-September, as the spread between 10-year Australian and U.S. Treasury yields narrowed to 1.42 percentage points on Oct. 19 from 2.32 percentage points a year earlier.

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