Carry Trades Explained
There have been many articles recently talking about carry trades and the possibility that the US dollar may become a preferred currency for carry trades. Essentially carry trades are when an investor sells a low yielding currency with a low interest rate and uses those funds to purchase a currency with a higher rate. The investor then attempts to capture the difference in interest rates. Depending on the amount of leverage used carry trades can net investors substantial profits—or losses. In a simple example an investor borrows 1,000 Japanese yen at a rate of 0%. The investor then converts the funds into euros and purchases a bond for that amount in euros. If the bond pays 5% and the yen rate is 0% then the investor will realize a profit of 5%. If the investor uses leverage of 10:1 the profit realized is 50%. It is not surprising to see why carry trades are popular with investors.
Asset Managers Predict US Dollar and Pound Will be Favored Carry Trade Currencies in 2010
At the Reuters Investment Summit in New York asset managers said that the strategy of using low yielding currencies to purchase high yielders will remain popular next year. Investors have taken advantage of record low US rates to fund carry trades yielding high returns. They predict that the British pound will join the US dollar as favored currencies for carry trades. The asset managers also said that the pound is their least favorite currency due to low rates, spending cuts and high taxes. Jonathan Xiong of Mellon Capital Management stated, “As long as the U.S. continues to remain in a negative real interest rate environment and the interest rate hikes are not aggressive enough, the dollar carry-trade could go on.” Xiong who manages $18 billion in assets also said that the pound will be the carry currency in the future “as long as (its) monetary policy is not pulled back.”
Aussie and Kiwi Chief Beneficiaries of Carry Trades
The chief beneficiaries of the carry trade have been the high yielding Aussie and Kiwi dollars. This year Australia was the first G 7 nation to raise rates. Aussie rates are now at 3.75% and are the highest in the industrialized world. New Zealand’s rates stand at 2.5% but New Zealand’s central bank has indicated it may raise rates sooner than previously thought. Mellon’s Xiong said that while the US, Japan, Europe and Britain are lagging behind the economies of Australia and New Zealand may recover enough to approach “trend growth” soon..
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