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(Bloomberg) -- The strengthening dollar and Swiss franc are upending the most popular trading strategy in the $5.3 trillion- a-day foreign-exchange market.

A Credit Suisse Group AG index that tracks returns from so- called carry trades, where investors borrow in nations with low interest rates such as the U.S. and Switzerland and invest the proceeds where they are higher, has tumbled 6.6 percent this month, the most in six years. The trade can quickly go awry if the funding currency appreciates, making it more expensive to pay back the loans.

With the dollar and franc both soaring, firms from Aberdeen Asset Management Plc to Goldman Sachs Group Inc. are changing tack, turning to currencies such as the euro and yen to buy India’s rupee, Turkey’s lira or Mexico’s peso. That may breathe new life into emerging-market currencies even as they languish at a 12-year low against the dollar.

“You can still make money in carry trades, but you have to be selective,” Viktor Szabo, who oversees $12 billion of developing-nation debt at Aberdeen in London, said Thursday by phone. Declines in developing nations’ currencies are “not about emerging-market weakness, but dollar strength.”

The dollar has effectively priced itself out of funding carry trades by strengthening against all its major peers in the past six months as the U.S. prepares to raise interest rates. At the same time, the euro, yen and Swedish krona are becoming more viable as their central banks debase the currencies as part of efforts to stimulate their economies.

Szabo said he’s buying the rupee, Indonesian rupiah, Mexican peso and Brazilian real in deals funded by currencies including the euro and Hungary’s forint.

Top Strategy

The carry trade is the most widely used foreign-exchange strategy, according to the Bank for International Settlements in Basel, Switzerland. Yet a benchmark index tracking the deals fell the most since 2008 this month as rising price swings eat into profits. An index of global currency volatility jumped to a 1 1/2-year high this month, threatening returns.

Hence the need to be selective. Citigroup, the world’s largest foreign-exchange trader, replaced the Swiss franc for the Swedish krona in one of its carry trades this month after the Alpine nation scrapped its exchange-rate cap, sending its currency to a record-high versus the euro.

Spreading Risk

The bank now recommends clients buy the rupee, lira and rupiah by selling the euro and krona.

“We continue to hold an emerging-market carry trade,” Citigroup strategists led by Jeremy Hale in London said in a client note on Thursday. “The trade makes sense as it provides diversification to a long-dollar portfolio.”

Buying a basket of the rupee, lira, real and South African rand, funded using a mixture of euros, yen, Czech koruna and Taiwanese dollars, would have made 3.9 percent this month, data compiled by Bloomberg show.

Contrast that with the slump in emerging-market currencies versus the dollar. An index of 20 major developing-nation exchange rates fell yesterday to the lowest since October 2002, leaving it just 0.6 percent from its weakest level since the data began in 1993. The gauge fell 0.64 percent on Jan. 26.

Crude Impact

The rupee and the lira are popular buys right now because their nations are net importers of oil, meaning they can benefit from lower crude prices. While the lira has fallen more than 3 percent against the dollar this month because of rate cuts by the central bank, the rupee is the best performer among 24 emerging-market currencies tracked by Bloomberg, strengthening almost 2 percent.

On the other side of the deals, surprise policy measures to loosen the money supply of the euro region, Canada and Norway this month made their currencies more appealing for funding carry trades.

Canada and Norway both unexpectedly lowered interest rates, while the European Central Bank unveiled a larger-than- anticipated 1.1 trillion-euro ($1.3 trillion) quantitative- easing program last week, sending its currency to an 11-year low on Jan. 26.

Euro-funded deals will continue to do well, according to Goldman Sachs, whose strategists recommend using the 19-nation currency to buy rupees, Mexican pesos and lira.

“Low yields in developed markets make relatively high yields in emerging economies very interesting,” Alejandro Urbina of Silva Capital Management LLC, which specializes in emerging-market currencies, said from Chicago on Jan. 27. “While volatility may be higher, if you pick your market correctly, it still makes sense.”

To contact the reporter on this story: Ye Xie in New York at yxie6@bloomberg.net To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net Paul Armstrong, Caroline Salas Gage

Bloomberg