Carry Trades May Boost Currency Volatility

The near-zero interest rates expected to persist in Japan, Europe and the U.S. for the next few years, encouraging so-called foreign exchange “carry” trades, pose challenges for higher-rate, emerging market countries such as Brazil, CME Group Chief Economist Blu Putnam said.

Brazil’s central bank faces a difficult task in balancing efforts to maintain stable interest rates, cushioning an economic slowdown and avoiding sharp swings in its currency, the real. In coming years, Brazil “will have to worry about increasing foreign exchange volatility,” Putnam said in a video interview.

“They don’t want the real to go up too fast because that will hurt their exports, and they don’t want it to go down too fast because that could raise inflation,” Putnam said.

Broadly defined, an investor making a carry trade sells a certain currency in a country with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher rate, attempting to profit on the rate difference.

With the U.S. and other industrial nations locked into a prolonged period of rates near zero, it’s becoming difficult for central banks in emerging-market countries to manage their own economies. “In a sense, there’s collateral damage, or at least collateral challenges, for the central banks of emerging market countries coming from the low-rate policies of the industrial countries,” Putnam said.

Video Length: 2:14 minutes