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Weaker US dollar boosts appetite for carry trades in currencies

The Australian dollar has climbed to a 25-month high against its US counterpart, underscoring investor appetite for owning currencies supported by higher interest rates.

The Aussie dollar heads a list of high-yielding currencies strengthening against the US unit in the past five days.

The trend reflects growing investor activity in the so-called carry trade, whereby investors borrow in these low-yielding currencies to buy high-yielding currencies, pocketing the difference in the process.

“Carry remains the king,” said Citigroup, noting the market sentiment in favour of risky assets which, along with low volatility and a falling dollar, is an optimum environment for the carry trade.

The Australian dollar has risen 4 per cent in the past fortnight with robust jobs data on Thursday providing the latest boost in sentiment. That leaves the antipodean currency worth as much as 80 US cents for the first time since May 2015.

Brazil’s real has gained 2 per cent while the South African rand is up 1.9 per cent over the past five days, reflecting how US dollar depreciation is the main driver of the forex market.

This has been triggered by Federal Reserve caution and poor US inflation data, which are pushing back market expectations of interest rate rises.

The dollar index, which measures the greenback against a basket of its major peers, gained a quarter of a per cent on Thursday as investors pared their euro positions ahead of the European Central Bank meeting.

But the index remains firmly in another downward phase, one of several over the course of this year, and is more than 2 per cent lower over the past 30 days.

“Affirmation of the policy status quo by [Fed chair] Janet Yellen and renewed US political uncertainty is keeping firm downward pressure on the USD,” said BNY Mellon forex strategist Neil Mellor.

At the same time, signs of policy normalisation by other central banks is exciting market attention.

The Bank of Canada’s rate rise last week, its first in seven years, has awoken investors to the prospect of other G10 policymakers following suit, with the Reserve Bank of Australia a leading contender.

Peter Kinsella at Commonwealth Bank of Australia said this week’s RBA minutes showed policymakers were less concerned about downside risks to growth while the jobs numbers indicated improvement in labour market dynamics.

“Consequently, I think markets will bring forward their expectations of RBA rate hikes and, barring a large surprise from the US, this will lead to robust AUD/USD exchange rates,” Mr Kinsella added.

The RBA next meets on August 4, prompting investors to focus on two upcoming events — a speech on monetary policy by RBA deputy governor Guy Debelle on Friday and Wednesday’s data on inflation.