June 14, 2024

What you need to know about the carry trade

In this series, we bust the jargon and explain a popular investing term or theme. Here it’s the carry trade

I suspect that this has nothing to do with transport…

You’d be right there. This 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 wildly popular on Wall Street – and this is set to be the case for the rest of this year.

Traders reckon that volatility in the currency markets is set to be low-ish. This assessment is based on the view that there will be fewer interest rate cuts in the UK, the US and elsewhere than economists were forecasting in January.

Inflation may be softening, but seems set to be stickier than earlier thought, especially in the US and maybe also in Australia.

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 its interest rate to 1.5 per cent in March, saying the country’s inflation rate would stay below 2 per cent. Meanwhile others, like Swiss asset manager Pictet, are keen on Brazil and Mexico.

Where is the current focus of the carry trade?

The yen-dollar ‘carry’ has been one of the hottest foreign exchange bets for a while: the value of the yen is close to a 34-year low. Traders have been making the most of Japan’s near-zero rates to buy this currency and use this cash to invest in the dollar and so profit from an annual rate of about 5 per cent.

Isn’t Japan bothered about this?

Japan has been intervening in the market to support its currency which may have further depressed by the carry trade.

It seems that the Bank of Japan, led by its governor Kazuo Ueda, may be ready to raise rates this month or next. Japan’s inflation rate now seems to be moving above 0 per cent, which had become the norm.

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But any increase already appears to have been priced in.

After all, there would still be a huge gap between Japan’s rate and those of other major economies which are, on average, above 4 per cent.

This sounds rather exciting. How can I get involved?

Foreign exchange (forex) operators offer carry-trade dealing 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 a sudden and very large loss if the value of the currency moves against you.

There could be a devaluation in the higher-interest-rate currency, reducing the value of your assets in this currency relative to those in the currency in which you have borrowed.

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