INVESTMENT FOCUS-Euro swings making investors wary of "carry trade"
By Anirban Nag
LONDON Oct 10 (Reuters) - Selling the euro against just about anything has made money since the European Central Bank cut its deposit rate below zero. But now investor appetite for the trade is dwindling, because big swings in exchange rates are making it look far more risky.
Negative rates on cash parked at the European Central Bank, imposed in June, made it cheaper for return-hungry investors to borrow euros to buy higher-yielding but riskier currencies - so-called "carry trades".
The euro dropped sharply against the likes of the Australian and New Zealand dollars and emerging market currencies including the Turkish lira, the South African rand and the Brazilian real.
But carry trades depend crucially on exchange rates staying stable. In recent weeks, long-dormant currency volatility began to stir, and now investors are pulling in their horns.
The euro hit two-year lows against the dollar this month as ECB and U.S. Federal Reserve monetary policies diverged. But the euro is recovering against a host of riskier currencies, and the derivatives market suggests these gains may have further to go.
Analysts say the single currency's rise has little to do with the euro zone's fundamentals, which are gloomy. Instead, it reflects concerns about how riskier currencies and economies that depend on capital inflows to fund external deficits will fare as the Fed prepares to tighten policy some time next year.
And doubts the ECB, which has pledged to do "whatever it takes" to safeguard the euro, will launch large-scale government bond purchases, known as quantitative easing, or QE, have undermined euro's role as a funding currency for carry trades.
"It is a combination of rising volatility and doubts about ECB QE that is seeing euro-funded carry trades take a breather," said Jonathan Webb, the head of FX strategy at U.S. securities firm Jefferies. "Unless you see the ECB expanding its balance sheet, investors will be cautious." Continuación...