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Currency traders that seek profits by borrowing in nations with low interest rates to fund purchases in countries with higher yields are losing more money than at any time in at least a decade.

The strategy lost 2.5 percent in 2010 as the dollar -- a favorite for financing the trades because of record low U.S. rates -- appreciated, according to an index compiled by UBS AG, the world’s second-largest foreign-exchange trader. That’s more than the 0.98 percent drop in 2008 when the collapse of Lehman Brothers Holdings Inc. caused credit markets to freeze and the worst performance for so-called carry trades since at least 1999 when UBS began releasing yearly figures.

Falling demand for carry trades may help the greenback extend a rally that drove IntercontinentalExchange Inc.’s U.S. Dollar Index up 4.5 percent from its 12-month low on Nov. 4. Gains in manufacturing and retail sales are leading investors to buy the dollar, rather than sell it to fund other investments.

“The U.S. will look reasonably better compared to other economies,” said Mitul Kotecha, Hong Kong-based head of global foreign-exchange strategy at Credit Agricole CIB, a unit of France’s second-biggest bank. “Bond yields will move higher, and that will certainly reduce substantially the attraction of the dollar as a funding currency.”

Futures traders cut bearish bets against the dollar last quarter by the most in a year, figures from the Commodity Futures Trading Commission in Washington showed.

Less Bearish

The difference in the number of wagers by large speculators on a decline in the currency compared with those on an advance - - so-called net shorts -- was 167,031 on Dec. 21, down 32 percent from 245,789 on Sept. 30. It was the biggest drop since a 49 percent decrease in the final quarter of 2009. The Dollar Index rallied 10.5 percent in the following six months.

The Dollar Index, which tracks the U.S. currency against the euro, yen, Swiss franc, Canadian dollar, British pound and Swedish krona, rose to 79.028 at the end of last week from the November low of 75.631. Over that period, the greenback advanced the most against the euro and the Danish krone of its 16 most widely traded counterparts. The index rose 0.3 percent to 79.374 as of 11:23 a.m. in New York today.

Strength in the dollar has run counter to predictions by officials in Japan, Germany and China who said the Federal Reserve’s plan to spark the economy by purchasing $600 billion of Treasuries through June would weaken the greenback....
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