With 3-month Turkish lira deposits now paying an annual interest rate of nearly 14%, the dodgier high-yield currencies look tempting to yield-hungry hedge funds. At a yield of 14%, the Turkish lira would have to depreciate from this morning’s 3.96 to the dollar to about 4.4 to the dollar for an investor to lose money. Currencies of countries with substantial current account deficits (for example the Turkish lira, the Mexican peso and the Brazilian real) have been weak all year, while Asian currencies have strengthened vs. the U.S. dollar.
Are the high-yielders worth the risk? A standard portfolio model says no. A computer-constructed portfolio with the highest Sharpe ratio (in this case the portfolio yield divided by the volatility, or standard deviation) would contain 90% Asian currencies–mainly India, Indonesia and the Philippines, and only 10% of the high yielders.