In this series we debunk the jargon and explain a popular investment term or theme. Here it is the carry trade
I suspect this has nothing to do with transportation…
You would be there. This is an investment strategy that aims to exploit the differences between the interest rates of two countries. You borrow in the currency with the lower interest rate to invest in the currency with the higher interest rate, assuming that you should earn a superior return, although the profit is of course not guaranteed.
Why are we reading about this now?
The carry trade is extremely popular on Wall Street – and will remain so for the rest of this year.
Traders assume 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 Britain, the US and elsewhere than economists forecast in January.
Inflation may be easing, but it appears to be more persistent than previously thought, especially in the US and perhaps Australia.
Making a mark: The carry trade is all the rage on Wall Street – and will remain so for the rest of this year
What will the big names bet on?
UBS is advising investors to sell the Swiss franc to buy US and Australian dollars. The Swiss National Bank cut interest rates to 1.5 percent in March, saying inflation in the country would remain below 2 percent. Meanwhile, others, such as Swiss asset manager Pictet, are interested in Brazil and Mexico.
What is the current focus of the carry trade?
The yen-dollar carry has been one of the hottest currency bets for a while now, with the yen’s value near a 34-year low. Traders have taken full advantage of Japan’s near-zero interest rates to buy this currency and use this money to invest in the dollar, taking advantage of an annual interest rate of around 5 percent.
Doesn’t Japan worry about that?
Japan has intervened in the market to support its currency, which may have fallen further due to the carry trade.
It appears that the Bank of Japan, led by Governor Kazuo Ueda, could be willing to raise rates this month or next. Japanese inflation now appears to be rising above 0 percent, which had become the norm.
But every increase seems to have already been priced in.
After all, there would still be a huge gap between Japanese interest rates and those of other major economies, which average above 4 percent.
This sounds quite exciting. How can I participate?
Foreign exchange (forex) operators offer carry trade transactions to retail investors. The principles of the carry trade may seem simple.
But any foray into forex is fraught with risk, with the possibility of a sudden and very large loss if the value of the currency moves against you.
There may be a devaluation of the currency with the higher interest rate, causing the value of your assets in this currency to decrease compared to those in the currency in which you borrowed.