The Silent Economic Driver that Moves the Markets
With the yen hitting new lows the USD is spiraling out of control, further cementing the stock market’s growth and higher returns of U.S treasuries. The yields of the U.S Treasuries compared to the bonds of other regions like Europe and Japan are much higher, which begs a lot of questions since they are a much safer investment. To some extent, the culprit behind this odd direction in the markets is the “carry trade”.
The carry trade is utilized by investors as a means to profit by shorting currencies with low borrowing interest rates, like the Japanese yen which nears 0% interest rate, and going long in higher interest rate securities in other countries. Even if the interest rate in another country is only marginally higher, with the use of leverage, traders can enjoy sizable returns. However, when this strategy is used by hedge funds or other financial giants, they can considerably affect the market and have a great impact on its bearing.
In forex, buying a currency with higher interest rates and selling the currency with the lower interest rates will get you a positive swap or positive carry. A great example for this is the AUD/USD pair. When you buy AUD/USD, therefore buying Australian dollars while selling USD, for every day you hold the position you get positive swaps, and if you take the leverage into account, you have a market with an estimated size of at least 2$ trillion dollars.
The main pitfall with the carry trade in the forex industry is the volatility and unpredictability of exchange rates. Any event that impacts a low or negative carry pair even modestly, can incur double the losses for a heavily leveraged position.
Traders who seek to take advantage of the carry trade strategy are looking for currencies in emerging economies which opt to hike interest rates, in order to pit against a currency with stagnating or shrinking interest rates. At the moment the president of the ECB, Mario Draghi, is a euro carry trader’s best friend, as he is taking measures to make the euro cheaper and cut down interest rates even further from the current 0.05%.
Carry traders aim to gain from the difference in interest between two currencies in the long term but must be extremely cautious of fluctuation in exchange rates and be highly modest with the leverage on their position as it could prove catastrophic for their account without a moment’s notice. To further capitalize on a carry trade, traders are advised to perform thorough market research in order to find a broker with competitive offerings in both spreads and swaps.
Written By Yiannis Georgiou, Head of Reception and Execution Departments, at Forex Time
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NOTES TO EDITORS
The FXTM brand name was founded by Andrey Dashin in December 2012. FXTM provides access to the global currency market and offers trading in forex, precious metals, Share CFDs, ETF CFDs and CFDs on Commodity Futures. Trading is available via MT4 and MT5 platforms with spreads starting from just 0.5 on the Standard MT4 trading platform and from 0.1 on the ECN.MT4 and ECN.MT5 trading platforms. Bespoke trading support and services are provided based on each client’s needs and ambitions - from novices, to experienced traders and institutional investors. ForexTime Limited is regulated by the Cyprus Securities and Exchange Commission (CySEC), with licence number 185/12 and FT Global limited is regulated by the International Financial Services Commission (IFSC) with licence numbers IFSC/60/345/TS/14 and IFSC/60/345/APM/14.
