Just jumpped into the trading world

Carry Trade Is Back, but With New Risks 2009/04/18

The carry trade is making a comeback, but in a new form and with new risks.

The old carry trade was a relatively predictable creature. It meant borrowing funds in low-interest rate currencies like the Japanese yen, and depositing them into stable high yielders like the Australian dollar — for easy returns.

[Carry trade]

Now, investors looking to profit from differences in interest rates have to turn to the Indonesian rupiah, the Brazilian real, or even the Russian ruble to generate results — far riskier propositions.

Critical to the strategy’s success was the notion that currencies like the yen and Australian dollar would trade in relatively foreseeable ways. The Aussie’s steady gains against the yen in 2006 and the first half of 2007 only added to profits from interest rate spreads.

Fast-forward to 2009 and funding currencies like the yen and the dollar are cheaper than ever. Interest rates in both countries are close to zero, with their central banks seemingly intent on printing money to escape recession.

Investors with funds in hand have plenty of places to park their money, with rates ranging from 7.5% in Indonesia, to 13% in Russia. Fear, meanwhile, is receding: Stocks are up, emerging market currencies are ticking higher, while bond offerings in the developing world are being snapped up.

Much of the carry trade’s success in its heyday rested on the enormous leverage that investors could deploy to magnify their returns. Leverage now, of course, is the dirtiest word in the financial lexicon.

And while the new carry trade may be less leveraged, it’s an inherently riskier bet. As such, it’s more vulnerable to the kind of swift unraveling of risk appetite observed across all nations and sectors in 2008, but which occurs with far more frequency in emerging markets.

Investors turning directly to the Indonesian rupiah have driven the currency nearly 12% higher against the dollar in the past month, and been rewarded by an event-free national election that will only bolster investment flows.

It pays to pick your currency carefully.



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