What carry trade, or why rates are important: Q A
This scheme seems to be a sure way to increase the profitability of assets - loans to buy them in cheaper vehicles. This principle is the basis of the currency carry trade. Taking advantage of the difference in interest rates between the two countries, investors borrow where the lower the rate, and is invested where it is high. decades investors use this strategy, betting on currencies such as the Australian dollar and the Mexican peso. Relatively recently, they have come to occupy in US dollars for investments in Russian assets, Brazil and other developing countries. Caution: in the carry trade can be quite easy to lose large sums of money, given that exchange rates are subject to unpredictable offsets, which can lead to a sudden and painful closing of positions.
How it works?
According to economic theory, this strategy does not work at all. High interest rates should mean that the country's poor fundamentals or high inflation, and consequently, its currency should become cheaper. Therefore, the difference between the interest rates of the two countries must reflect the pace at which, according to investors' forecasts, the currency of the country with higher interest rates will fall in price relative to the currency of the country with low interest rates.
Then why does it work?
In practice, in pursuit of high returns, investors are usually willing to overlook bad fundamentals, if the profit is high enough. Then do the carry traders contribute to the strengthening of the national currency with high interest rates, investing in it, and when the strengthening of starts, the number of those wishing to join this strategy, and the currency more expensive. Besides theoretical foundation does not always match reality. Sometimes central banks to raise interest rates in the turning points in an attempt to rectify the situation in the economy by stimulating the appreciation of the country's assets. Brazil and Russia, in particular, attracted carry traders because the central banks of these countries have raised interest rates in a collapse in commodity prices.
What is the profit?
Risk-adjusted carry trade is generally more profitable investments in shares. Bloomberg index Cumulative FX Carry Trade, which tracks the performance of eight emerging market currencies against the dollar, bringing a positive return over the 11 of the last 17 years.
What could go wrong?
Economists compared the carry trade with the collection of coins in front rollers: it is possible to have time to collect the money, but if you linger - you crush. US hedge fund FX Concepts collapsed in 2013, failing to respond to the decision of central banks around the world cut interest rates to near zero. Another good example: in just one week in 1998, the yen has risen against the dollar by 16 percent, and the carry-traders over the years to gain from yen to invest in any other currency, faced with nothing.
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