Tuesday, February 10, 2009

When Will the USD Carry Trade Finish Unwinding?

Back in Oct 08, I speculated that USD had become a major carry-trade currency, along with JPY. Bad news for US economy made USD stronger, much like what had been happening to JPY for the past few years. That was a dramatic reversal against the usual carry-trade target currencies such as AUD and CHF (Swiss Franc), and to a somewhat lesser degree EUR and GBP, since early 06. FX rates are one of the most complex dynamics in the complex dynamics of financial world. But when bad news is good news for a currency, it's a sure sign of it being a pivotal carry-trade currency.

Recently, and especially today, we're seeing another proof of USD and JPY being the carry-trade currencies. It's implausible to argue the recent USD strength has anything to do with safety or even risk aversion, the latter being the usual explanation for carry-trade currency strength. It's more like forced, maybe even panicking, unwind of existing carry trades.

Hence lies the surprise to me as a casual observer of the FX market: what, there's still a massive amount of carry trades open, a year and half after the crisis blew up in the US and half a year after the crisis became an exported, global one?

But the more interesting question is this: when will this unwinding finish and bad news for US economy becomes bad news for USD? That would mark the next turning point in the dynamics for USD and JPY.

I would appreciate readers' enlightenment as to how to find data, or even if just a guesstimate, on the scope of carry trades.

6 comments:

rose said...

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Lucy

http://forextradin-g.net

Bo Peng said...

Thanks, Lucy. But I haven't kept this up to date. I've been writing about trading on SeekingAlpha. Check it out:

http://seekingalpha.com/author/bo-peng

fashion said...

Could you explain what if anything the carry trade creates that is valuable to society? Or does it simply create more inflation

Bo Peng said...

Hi fashion, I can't think of beneficial social effects carry trades have. It partially cancels out the effect of monetary policy of a country and makes it harder to control. When a central bank raises rates in hope to control inflation, carry trades come in and buy the currency, therefore increasing the money supply. For small economies and weak cenbanks, the carry trade effect could even overwhelm the cooling effects of higher rates. It's a classic example of mixing free market with centrally planned policy (cenbank).

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I thought that the risk in carry trading is that foreign exchange rates may change to the effect that the investor would have to pay back more expensive currency with less valuable currency