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Joined Mar 2006
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Status: Pip Samurai
|975 Posts
The carry trade takes advantage of low interest rates in one country to buy currencies in a higher yielding currency.
Most of these involve the yen which have had very low interest rates for quite some time. Basically, people were borrowing the Yen at cheap rates and buying other currencies like the GBP or USD.
As the Yen strengthens, however, the trades become more expensive and thus, slowly but surely, people liquidate their long positions in the GBP or USD to buy back the Yen they borrowed.
When this happens, the Yen strengthens against the other currencies, and this begins to cascade. Even though the Yen interest rates are still pretty low, trades that were started later in the cycle start hitting stops, which forces the cross currencies lower and literally snowballs until enough buying takes place to stop the fall.
Too much strengthening too quickly would cause a recession in Japan, which would cause the BoJ to lower interest rates, which would have the opposite effect...so there IS a floor to the unwinding...but new carry trades won't really come into play until the volatility comes down a little bit as the one thing that keeps traders away from carry trades is high volatility. As volatility shrinks, carry traders take out larger bets...as volatility grows, they pair their bets down.
[quote=mrmikal;235698]The carry trade takes advantage of low interest rates in one country to buy currencies in a higher yielding currency.quote]
Thanks a lot for the nice explanation. Are we talking about people doing this via the forex spot market or are they literally borrowing JPY funds with a note and then buying other currencies?
The carry trade takes advantage of low interest rates in one country to buy currencies in a higher yielding currency.quote]
Thanks a lot for the nice explanation. Are we talking about people doing this via the forex spot market or are they literally borrowing JPY funds with a note and then buying other currencies?
Ignored
The wee people are doing it in the spot forex market, the big money is actually taking out yen denominated loans.
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Joined Mar 2006
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Status: Pip Samurai
|975 Posts
Dark,
Right...technically, larger institutions (like banks and mutual funds) were borrowing Yen and investing in USD and other currency dominated securities...which essentially has the same effect...as the price of the Yen falls, the loans become cheaper to pay off...as the price of the Yen rises, the loans become more expensive. At some point, the advantage of keeping the loans versus paying it off reaches a threshold, and players must start repaying those loans (by selling the securities).
This is one of the major factors for the drop in equities recently, as players that invested in US equities have had to sell those equities in order to pay back their Yen loans. It isn't the main drive, but it's one of the reasons for the drop...
