Draghi Makes Euro Favorite for Most-Profitable Carry Trades With Rate Cuts

Betting against the euro may be the most profitable trade in the foreign-exchange market as policy efforts to stave off a European recession debases the currency. Borrowing in euros and investing in the currencies of Australia, Brazil,Mexico, South Africa and South Korea has returned 7.8 percent since the European Central Bank cut its benchmark interest rate on Nov. 3 for the first time in more than two years, according to data compiled by Bloomberg. So- called carry trades funded with yen have lost 0.3 percent and gained 1 percent when financed with dollars. While a debt crisis entering its third year has driven the region’s shares to the cheapest levels since 2004 compared with the U.S. and the sovereign-bond market posted its biggest rally on record last month, euro bears say the currency won’t rebound anytime soon to wreck carry-trade profits. With government austerity measures threatening growth, ECB President Mario Draghi may have to cut rates to prop up an economy the World Bank expects to contract. “We’re seeing a very clear breakdown in the correlation between the euro and risky assets,” said Ian Stannard, head of European currency strategy at Morgan Stanley in London. “That highlights the fact that the euro is increasingly becoming a funding currency.”

Carry trades funded with one million of euros to buy Australia’s dollar, Brazil’s real, Mexico’s peso, South Africa’s rand and South Korea’s won returned 27 percent, or 270,000 euros, during the two years the ECB held the benchmark rate at 1 percent through April 2011, according to Bloomberg data. “It’s unlikely that the authorities will move to avoid the softening of the currency, therefore, it becomes a more attractive carry trade,” Tim Riddell, head of global markets research in Singapore at Australia & New Zealand Banking Group Ltd., said of the euro in a Jan. 16 telephone interview. “Other currencies which have effectively low or zero rates, such as the dollar and yen, are facing a slightly better growth profile.” The World Bank said this month that the economy in the euro area will probably contract 0.3 percent this year, compared with global growth of 2.5 percent. Leaders, including Draghi and German Chancellor Angela Merkel, will gather in Davos, Switzerland, this week to discuss tackling the crisis without depressing the economy. “Short positions have accumulated, and positive headlines are likely to spark an unwinding of these positions in the near term,” said Masashi Murata, a currency strategist in Tokyo at Brown Brothers Harriman & Co.

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