The next level of carry

The next level of carry trades is not looking just for the high yielding currencies but trying to anticipate the change in yields. By anticipating the change in yields, investors are trying to pick up the potential gain in currencies from a further increase in yields or the differential in yields. A simple case can be seen with the move in the Swedish krona which has had the biggest gain in four years in response to the Riksbank raising rates.

The combination of a rate rise with the discussion that there may be further increases has caused money to pore into the currency. Rates have moved up a quarter of a point to 3.5% but there is the anticipation that rates will move up to 4% by the end of the year. While this does not place Sweden in the class of high yielders, there is a clear movement to the higher-end. There is a willingness to substitute the Krona for other currencies with similar risk

Modeling the term structure changes and yield changes does lead to improvement relative to the simple strategy of picking levels, but the gain from following these strategies is highly variable. The impact of the yield change on the currency is not certain. In fact, recent research suggests that currencies still seem to follow a random walk and have not a close link with changes in nominal yields.

Anticipating yield changes is similar to anticipating mergers, there is compensation with making guesses but the level of risk is much higher than a simple strategy of holding high yielders. But, when the gains from carry are diminished in the developed currencies, there is a willing to reach for return.