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Guest Commentary: Carry Trading? Beware of Overweight

Guest Commentary: Carry Trading? Beware of Overweight

2011-10-07 21:18:00
Yoham Elay, Forex Crunch,
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The carry trade was popular for quite some time before the crisis, but is still eyed by many. Is it the time to return to long term carry trading? Probably not.

The carry trade was usually done by buying AUD/JPY or NZD/JPY. The idea was to sit on a position for a long time, and enjoy the interest rate differentials. Japan has a traditionally low or nonexistent rate, while Australia and New Zealand had very high rates. Even after the crisis and after the cuts, this rate remains high.

During the crisis the yen was sought after as a safe haven currency. The “risky” Aussie and Kiwi were dumped. The interest rate differential wasn’t close to covering the loss in the exchange rates.

Is it back?

The yen strengthened quite a lot, but seems to have reached a bottom against the dollar. The new all-time low is a line that the pair “fears” of. An intervention to weaken the yen happened quite a few times in the past year, and is always an option. Japanese officials are “closely watching” foreign exchange rates all the time.

So perhaps sitting on AUD/JPY can not only provide a profit through the carry trade, but may also ride on the next intervention, whenever it happens.

Well, not so fast.

An intervention in Japan isn’t certain. The Japanese authorities already intervened when USD/JPY was at higher levels, only to see their short lived action result in an even lower rate. This happened even when the intervention was coordinated with other countries. So, the yen may stay still or even strengthen a bit more.

In addition, the Aussie and the kiwi pose greater risk now. Both countries rely on demand from Asia. This is what boosted their economies and their currencies after the crisis. Australia even avoided an official recession.

But this has changed now: Asia cannot decouple from the rest of the world and cannot keep growing so fast. This paves the way for more weakness in both currencies.

Even if you rely solely on the interest rates, also this can prove to be a slippery slope. Rate cuts can happen in both countries.

Did you carry trade in the past? Are you using this method now?

Further reading: 5 Most Predictable Currency Pairs – Q4 2011

By Yohay Elam, Forex Crunch

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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