The euro's fall has come to the rescue of carry traders looking to invest in emerging market currencies. Such trades, where borrowed euros are used to invest in high-yielding emerging market (EM) currencies, have recorded lucrative profits to the tune of about 29% this year, depending on the choice of the EM currency, reported Bloomberg.
What’s A Carry Trade? In simple terms, a carry trade can be defined as one where funds borrowed at a lower interest rate are deployed in higher-yielding assets to generate returns.
The Euro Factor: The dollar is one of the preferred currencies to fund carry trades because of ultra-low interest rates in the U.S. However, the rise in U.S. inflation and the subsequent interest rate hikes by the Fed lowered gains in the carry trades involving the greenback.
With the euro's 10% drop against the dollar, it became an ideal choice for a carry trade.
For example, carry trades involving the euro and the Brazilian real provided 28.8% returns as against the same carry trade involving a dollar, where the returns stood at 14.8% on a year-to-date basis, according to Bloomberg.
Expert Take: Brendan McKenna, a currency strategist at Wells Fargo in New York, told Bloomberg that funding carry trades by selling euro is becoming more common. “The European Union looks more likely to fall into recession, and geopolitical developments should weigh on the currency, making emerging-market carry trades funded by the euro an interesting option,” he said.
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