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In this series, we break down the jargon and explain a popular investing term or topic. Here is the carry trade.
I suspect this has nothing to do with transportation…
You would be right there. It is an investment strategy that aims to exploit the differentials between the interest rates of two nations. You borrow in the currency with the low interest rate to invest in the currency with the higher rate, calculating that you should enjoy superior returns, although of course profits are not guaranteed.
Why are we reading about this now?
The carry trade is tremendously popular on Wall Street, and will be for the rest of this year.
Traders believe that volatility in the currency markets will be low. This assessment is based on the view that there will be fewer interest rate cuts in the UK, US and elsewhere than economists predicted in January.
Inflation may be weakening, but it looks set to be stiffer than previously thought, especially in the United States and perhaps Australia as well.
Making a mark: The carry trade is wildly popular on Wall Street, and will be for the rest of this year.
What will the big names bet on?
UBS advises investors to sell the Swiss franc to buy US and Australian dollars. The Swiss National Bank cut its interest rate to 1.5 percent in March, saying the country’s inflation rate would remain below 2 percent. Meanwhile, others, such as Swiss asset manager Pictet, are interested in Brazil and Mexico.
Where is the current focus of the carry trade?
The yen-dollar carry has been one of the hottest currency bets for some time: the value of the yen is near its 34-year low. Traders have been taking full advantage of Japan’s near-zero rates to buy this currency and use this cash to invest in dollars to benefit from an annual rate of around 5 percent.
Isn’t Japan worried about this?
Japan has been intervening in the market to support its currency, which may have been further depressed by the carry trade.
It appears that the Bank of Japan, led by Governor Kazuo Ueda, may be willing to raise rates this month or next. Japan’s inflation rate now appears to be above 0 percent, which had become the norm.
But any increase appears to have already been discounted.
After all, there would still be a huge gap between Japan’s rate and that of other major economies, which, on average, are above 4 percent.
This sounds pretty exciting. How can I get involved?
Foreign exchange (forex) traders offer carry-trading for private investors. The principles of the carry trade may seem simple.
But any foray into Forex is fraught with risk, with the possibility of suffering a sudden and very large loss if the value of the currency moves against you.
There could be a devaluation in the currency with higher interest rates, reducing the value of your assets in this currency relative to those in the currency in which you borrowed.