The New Carry Trade?

After last year's collapse of the carry trade, along with everything else, some traders wondered what to do with the Yen. Japan, years ahead of everybody else, had cut interest rate to the bone. When the major central banks world wide followed with something similar in 2007 to 2008 it had the predictable effect of causing the yen to gain value, exacerbated by the fact that money, borrowed in Yen to invest in equity markets world wide, was now being paid back. Quote:

Sep. 30 (Guardian UK) -- Japan's finance minister, Hirohisa Fujii, has not ruled out intervention to rein in the yen in an apparent attempt to backtrack on comments favouring a strong Japanese currency because it helps domestic demand.

We now have a situation where interest rates are being increased again for various reasons, but primarily as a crude tool to curb inflation. Australia and New Zealand have been at the forefront. Quote:

Oct. 15 (Bloomberg) -- The Australian dollar rose to a 14 month high after Reserve Bank Governor Glenn Stevens said the central bank can’t be “too timid” in raising interest rates. New Zealand’s currency also advanced.
The Aussie gained against most of its major counterparts after the comment spurred speculation the bank will add to last week’s unexpected rate increase on mounting evidence economic growth will accelerate. New Zealand’s dollar jumped to the highest level since July 2008 as a report showed third-quarter inflation accelerated faster than economists forecast.

A glance at the monthly chart should make it clear to any trader that the scales have been dealt a hefty whack and now we are seeing the correction, or retracement as we like to call it.

Added to that we have useful interest rate differentials again, not in the US Dollar and Pound Sterling as it was way back, but in the Aussie Dollar and Kiwi Dollar.

Thirdly - given that the new Japanese government will not rule out intervention to prop up USD/JPY if it makes any sudden moves this can only strengthen the AUD/JPY and NZD/JPY.

Long, long and long.

Hi, I just spoke to a sales guy from an online forex brokerage. He was explaining about the carry trade, saying that he "knew something about it" - I was just a little surprised when he said that the USD has "traditionally been a funding currency"..... This seems completely off to me!! This has lead me to look into the carrytrade a little - so here's a very basic question:

- Is it not true that the USD has been a relative "high yielder" for a period from around early 2006 to late 2007, when rates where high?

Another question: was the world "funding risk" in USD in 2003/4 when USD overnight rates bottomed out at 1%? (I wasn't following the markets then, so I simply do not know)

Thanks, would really appreciate your comments on this

I have only been trading currencies for about 3 years and equities for about 6 - 7 years and so I do not consider myself an expert. I agree that the USD has been traditionally a funding currency for commerce but for our purposes, trading currencies yield from USD has been good against the Yen from 2005 until the middle of 2007. Just look at the chart.

We are now seeing declines in value of USD and GBP for various different reasons, not least the economy declining and quantitative easing. The Yen is gaining value currently not because of the collapse of the carry trade bubble. That has already happened.

My point (or question) was that buying AUD and NZD with Yen is currently a good deal with interest rate differentials as they are. (This week excepted of course )

Thanks for that. I am trying to understand this specific info about the USD: if I look at the chart of the fed funds rate, I can see that it bottomed out at 1% in June 2003 until May 2004. Then it climbed steadily at 25 BP increments until it reached 5,25% in June 2006.

What I ask is if the following "statements" are true:

1) From June 2003 - May 2004 the USD was a "funding currency"

then rates went up and:

2) From June 2006 until Aug 2007, the USD was a "high yielder"

This is probably an extremely simplistic observation, because also other currencies' rates moved in that period, of course. However, I am trying to understand if is correct to say that the USD is "changing face" frequently, so to speak.

I hope I have been clear in my "crazy" question:-)

Smikester I can only say you are a genious. Why, thank you. Did you take the trade? No. You tit.

I think one of the next big carry trades will be GBP. In the 70's when debt was 40% of GDP we ended up with a tax of 98% on earnings over around 20k.

Debt is higher this time round. The elections will be in may and I expect the conservatives will raise taxes quicker than labour that mentioned they would do it next year.

If your in the carry trade purely for the accrued interest your gonna get killed at some point because the risk adjusted returns on the interest are negative. The trick is in getting into a currency BEFORE the interest rates start rising. Then as rate differentials expand, money flows into the higher yield market and you collect the alpha. The interest is just a bonus.

Australia and nzd are good trades today, as they have been for the last several months, because they are in the midst of raising rates. Aus is ~75bp away from a long term interest rate hold. At that point, they may throw off great interest, but the vol will eat you alive.

If your thinking about future opportunities, USD is where you want to be. By the end of the year the fed will begin a long series of interest rate increases (just as they did back in '03-'04). When that happens, the usd as a funding currency will end and it will start a steady climb against most of the other majors.

Jpy will likely resume its role as international funding currency because there is near zero likelihood of any appreciable interest rate increases in their future.

Long story short, ALL currencies go through periods of operating as both a funding currency and a high-yielder. It depends on what is going on in their economy and the resultant probability of changes in interest rates.

Could not have said it better myself. The markets tend to return to previous points and when things start to come back on line it will be not the interest that compels people to trade but the fact that there is a greater reward to be held by those who look to hold trades into the future. The interest will be, as dividends are to blue chips shares, a bonus that can be re-invested.