Forex carry trade, after months of obscurity, is making a come back. For those who forgot what it was, carry trade involves borrowing(selling) low interest currencies and buying higher paying ones. Idea is to collect the interest rate differential, on top of price appreciation which this action is expected to bring. For many years Japanese Yen has been the center of attention when it came to the carry trade. Couple of decades of cheap money(abysmal interest rates) led to using JPY as financing mechanism for all kinds of speculative investments. In the end, it all came crushing down last year, an event, or process, known as the “unwind” of the carry trade. During those few months, in tandem with global financial panic, Yen rose to dizzying levels, in some cases registering all time highs. In response, all central banks embarked on interest cutting campaign, putting an end to the carry trade. It fell dormant.

Now that the economy stabilized and central banks are no longer taking new active easing steps, the carry trade is making its way back to spotlight. Granted, the rate differentials are much smaller than they used to be, but they exist. Also, money appears to be flowing into currencies of economies most likely to be first to start raising its benchmarks, such as Australia or New Zealand. This has been already recognized by RBNZ, as one of the reasons for NZD’s recent surge. What has changed is the source of financing for this resurrected activity. Its no longer the Japanese Yen, but the US Dollar. This time around its FED, that fuels insatiable appetite for cheap money. Three months dollar based LIBOR dropped to 0.292%, while similar Yen based instrument is at 0.352%. It is cheaper to borrow dollar. Speculators see it and try to take advantage of. It is hard to say if this particular trend will last but conditions seem ripe for continuation, especially if FED stays with low rates policy.

Another sign that the carry trade is back came from London. FTSE Group in cooperation with Record Currency Management announced a plan to introduce indices set to track the money flow into the carry trade. The idea is based on a fact, that, by some measurements, this activity creates returns comparable to equities over long term. At the same time it has smaller volatility, in the range of bonds. This means lower drawdowns and smother performance. I would like to see how last years collapse is reflected in those indices, is it really smaller than the world wide slump in stocks? More details will be released later on this week. Introduction of these indices is important for two separate reasons. First, there will be one more, potentially useful, fundamental to help make a decision, and chart junkies, like me, will have yet another graph to study. While this sounds boring, second reason is more practical. Since these indices are being introduced in London, center of ETF innovation, it is very reasonable to expect ETF tracking carry trade activity to be introduced soon. If this indeed happens, an average person will be able to participate in a broadly executed carry trade without direct exposure. From Wall Street to Main Street, in a manner of speech.

Direct Forex trading is a little more complicated than buying and index based ETF. Not everything goes as planned, some concepts and implementation need more attention other than buy and hold. Good example is my trade in EUR-CAD trade, introduced in the Euro swaps post. Looks that I’m using 4H, intermediate time frame, when it come to trade selection, so everything takes a little longer.

Original trade happened on a breakout above 1.5855. In my original post I suggested possibility of deep pull backs, based on recent tendencies of this pair. Another entry took place an a reaction at 100SMA. Wrong wording- anticipated reaction. One never knows for sure, trading is based on risk taking. We believe these are “measured risks”or “educated guesses”, but every single trade is some function of taking a chance, with financial consequences. Positive, we hope. At any rate, EUR-CAD made a strong move today, almost reaching previous high. I closed the second trade at 1.5840, for 180 pips gain. Original trade remains open, still waiting for a more decisive run. That one has a 300 pips objective, so, if market doesn’t change its behavior, I’ll be managing this trade for some time.

Mike K.