The carry trade has been a mainstay in foreign currency trading, yet it has fallen on hard times in the post financial crisis period. Clearly, if there are no differences in interest rates across countries, there is no reason to buy the interest differential. The trades would be based on noise.
The international rate markets are now seeing an increase in yield differentials. Some key countries who have forced interest rates to zero or lower are saying we don't want the cash. Differences in monetary policies are leading to differences in rates which may make carry more attractive. There will be more opportunities for carry trade to make a compact, but of course, this will not be without risks. In fact, this has been a poor period for the simple reason that current rates suggest that the US dollar should still be a funding currency. The dollar flows have been based on expected future differentials which will be more favorable toward dollar rate investments.
Periods of transition to greater rate differentials can be filled with investment peril. Greater monetary policy uncertainty will translate into higher currency volatility. In a low manipulated interest rate world, it is harder to say what is a safe asset, a fair rate for sovereign risk, or a store of monetary value. With emerging markets still having higher rate differentials, there is the assumption that carry should work. That has not been the case and has been an investment failure over the last year.
The key negative to carry trades is the higher volatility and the economic risks from a slowdown that will cause flow into safe assets. Carry has historically been a negative skew investment with a high correlation to equity or economic growth risk. The time to stay out of carry has been heightened in the current market environment. The premium is on safety not yield regardless of what the Fed is thinking.
The international rate markets are now seeing an increase in yield differentials. Some key countries who have forced interest rates to zero or lower are saying we don't want the cash. Differences in monetary policies are leading to differences in rates which may make carry more attractive. There will be more opportunities for carry trade to make a compact, but of course, this will not be without risks. In fact, this has been a poor period for the simple reason that current rates suggest that the US dollar should still be a funding currency. The dollar flows have been based on expected future differentials which will be more favorable toward dollar rate investments.
Periods of transition to greater rate differentials can be filled with investment peril. Greater monetary policy uncertainty will translate into higher currency volatility. In a low manipulated interest rate world, it is harder to say what is a safe asset, a fair rate for sovereign risk, or a store of monetary value. With emerging markets still having higher rate differentials, there is the assumption that carry should work. That has not been the case and has been an investment failure over the last year.
The key negative to carry trades is the higher volatility and the economic risks from a slowdown that will cause flow into safe assets. Carry has historically been a negative skew investment with a high correlation to equity or economic growth risk. The time to stay out of carry has been heightened in the current market environment. The premium is on safety not yield regardless of what the Fed is thinking.
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