The Euro has found a new role in the carry trade, as the interest rate differential with other G10 currencies widens and as its value slides, in particular against the USD.
The purpose of the LTRO facility had been to ease liquidity pressures. With interest rates down to about 1%, banks could obtain funding at cheap rates. But the measure also revived the carry trade, as the banks can now borrow the Euro to buy peripheral Eurozone debt, or other non-Eurozone high-yielding debt.
The sovereign debt crisis has not yet reached a resolution, leaving the door open to the carry trade for a while yet. The crisis needs to worsen before the ECB and the EU leadership is forced to take the decisions they have so far avoided. Marinov says: "Very high borrowing costs for many euro zone sovereigns, as well as more evidence of worsening euro zone economic contraction should result in more decisive resolution of the crisis."
The carry trade is not necessarily the best form of currency management, says Lancioni. He says an active and diversified currency strategy can be a valuable source of alpha for investors looking for uncorrelated returns, when added to a multi-asset-class portfolio.
As the unwinding of the Yen trade demonstrated, there was a strong correlation between FX and the equities markets, and currency managers were unable to provide diversification when it was most needed.
Most of the currency investments went to strategies that "were not necessarily designed to be uncorrelated to risky assets. In our view, defining the investment process is the key element in designing a currency strategy that aims to offer diversification potential."
The complexity of these market dynamics is hard to capture by strategies like carry or momentum, says Lancioni. "Neither strategy is supported by strong fundamental reasons. In our opinion, currency investors have a better chance to capture alpha by adopting a more fundamentally based and diversified investment approach."