Profiting From Carry Trades And Interest Rate Differentials – The U.S. Dollar and Euro banknotes can be seen in this photo taken on July 17, 2022. /Dado Ruvic/Illustration Acquire Licensing Rights

LONDON/SINGAPORE, July 26 () – A slide in the dollar and signs of returning volatility in foreign exchange markets as interest rate hikes are causing investors to re-evaluate the ever-popular carry trades and rather choose which currencies they return.

Profiting From Carry Trades And Interest Rate Differentials

Profiting From Carry Trades And Interest Rate Differentials

The carry trade – an investment strategy that takes advantage of differences in borrowing costs between countries – has delivered bumper returns this year as most central banks have raised rates, causing the of yields, but at different rates.

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“The world’s favorite carry trade,” according to Bank of America, involves investors borrowing Japanese yen where the central bank has pegged low rates, and converting them into Mexican pesos to buy higher yield bonds.

One-year bond yields are around 0.1% in negative territory in Japan , but their Mexican counterparts are yielding around 11%.

A hypothetical $50,000 invested in a short yen, long peso carry trade for the first six months of the year would yield a profit of $15,100, according to Refinitiv Eikon.

“Carry is very focused in the first half of the year,” said Kamakshya Trivedi, head of global FX, rates and EM strategy at Goldman Sachs. “Something like 70% of the cross section of moves (in EM currencies) can be explained by the carry.”

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Deutsche Bank’s emerging market carry strategy index had its best year on record in the 12 months to May.

But trading could be jolted this week as the Federal Reserve, European Central Bank and Bank of Japan set interest rates and provide clues on the monetary policy outlook.

“You have to worry about some of these tighter positions,” said Stephen Gallo, European head of FX strategy at BMO Capital Markets.

Profiting From Carry Trades And Interest Rate Differentials

Gallo said a pick-up in market volatility or a drop in EM interest rates could trigger a rush for exits.

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James Athey, director of investment at abrdn, said: “Things like the Mexican peso have been positioned for a long time, it’s more like you’re taking pennies in front of a steamroller.”

Volatility is important, as an appreciation in the currency in which investors borrow, or a reduction in the one in which they invest, can wipe out profits from yield differences.

The yen hinted at snapping back, firming from 145 per dollar to 137 in the first half of July.

“I think that’s enough to offset any carry trade profits,” said Yujiro Goto, head of FX strategy for Japan at Nomura.

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Volatility has been low this year because most central banks have raised interest rates in tandem and there has been little damage to the global economy, said Oliver Brennan, FX volatility strategist at BNP Paribas.

Today, things look different: the Fed looks set to pause, the Bank of England still has ground to cover, some emerging market central banks are considering cuts, and the Bank of Japan is keeping traders guessing.

Volatility in the world’s five most-traded currencies fell to its lowest in a year and a half in June, according to CME Group’s options-based volatility gauge, but has since edged higher.

Profiting From Carry Trades And Interest Rate Differentials

Emerging markets are not the only focus. Investors also flocked to higher U.S. bond yield compared to many countries by “long” in the dollar.

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However, the greenback fell 2% against a basket of major currencies this month, after a sharp slowdown in U.S. inflation. in June raised hopes that the Federal Reserve was nearing its final interest rate hike.

This “benign disinflation” in the U.S. could help dollar-funded emerging markets continue to perform well, said Robin Winkler, FX strategist at Deutsche Bank.

“In the G10, however, the negative USD turn is not necessarily positive for carry, seeing as the USD is a favored long,” he said.

“In particular, the Japanese yen, but also the Swiss franc and Swedish or Norwegian kroner, have been used as funding currencies for the long term of the USD,” he said. “As a result, these USD pairs have come under intense pressure.”

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A hypothetical $50,000 invested in a short Norwegian crown, long dollar carry trade in the first three weeks of July would lose $3,000, according to Refinitiv.

Goldman’s Trivedi said the carry trade could still reap rewards, especially if emerging markets are boosted by Chinese stimulus. He recommends not just picking the highest-yielding currencies, however.

“Adding currencies that have a lot of cyclical exposure makes sense, given a world where growth is going to be stronger… that includes things like the Brazilian real in Latin America or the Korean won in Asia.”

Profiting From Carry Trades And Interest Rate Differentials

“Just be selective right now,” he said. “You just don’t want to double up, or triple up, on risk exposure.”

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Reporting by Harry Robertson and Alun John in London and Ankur Banarjee in Singapore; additional reporting by Rae Wee in Singapore; Editing by Bernadette Baum Trading strategies refers to a set of techniques and strategies that traders use to make informed decisions about buying, selling, or holding financial assets such as stocks , bonds, commodities, or currencies.

These strategies aim to maximize profits and minimize risks by analyzing market trends, analyzing financial statements, and using mathematical models and statistical methods.

Trading strategies are an important aspect of the investment process and are often customized to the investor’s financial goals, risk tolerance, and time horizon.

The main objective of various trading strategies is to help investors make informed investment decisions based on a systematic approach.

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Trading strategies provide investors with a framework to analyze market conditions, identify investment opportunities, and execute trades accordingly.

By using a trading strategy, investors can reduce the impact of emotions and biases on their investment decisions and rely on objective data and analysis.

Moreover, trading strategies allow investors to manage their portfolio risk effectively, ensure diversification, and achieve consistent returns over time.

Profiting From Carry Trades And Interest Rate Differentials

There are different types of trading strategies that investors can use to achieve their financial goals. These strategies can be broadly classified into five categories: fundamental, technical, quantitative, options and forex trading.

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The main trading strategies are based on the analysis of the company’s financial and economic data. These strategies aim to identify undervalued or overvalued stocks and invest in them based on their intrinsic value.

Technical trading strategies are based on the analysis of market data such as price movements, trading volume, and other indicators.

These strategies aim to identify patterns and trends in the market and make investment decisions based on them.

These trading strategies are based on mathematical and statistical models and algorithms. These techniques aim to identify patterns and signals in market data and make investment decisions based on them.

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In this investment strategy, the investor engages in buying and selling options contracts that give them the right to buy or sell the underlying asset at a predetermined price and time, but not an obligation to do so .

Forex trading, also known as foreign exchange trading, is the buying and selling of currencies on the global foreign exchange market. Forex trading is one of the most liquid markets in the world, with a daily turnover of more than $7.5 trillion.

Value investing involves buying stocks that are undervalued based on their financial statements and other data. Value investors believe that the market is inefficient and that stocks can be mispriced for a variety of reasons.

Profiting From Carry Trades And Interest Rate Differentials

On the other hand, growth investing focuses on investing in companies with high potential for growth and expansion. Growth investors look for companies with strong revenue growth and high earnings growth rates.

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This includes buying stocks that pay high dividends and provide a regular stream of income. Income investors are often retirees or other individuals looking for a steady source of income from their investments.

Dividend investors look for companies with a solid track record of paying dividends, even in tough economic times.

Technical trading strategies involve analyzing market data, such as price movements and trading volume, to identify patterns and trends:

The first strategy under this category involves investing in assets that are trending up or down based on their past performance.

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Trend followers believe that trends tend to continue and that trending assets will continue to perform well in the future.

Momentum trading involves investing in assets that have recently shown strong price movements, with the expectation that the trend will continue.

This involves buying and holding stocks for a short period of time, usually a few days to a few weeks, to take advantage of short-term price changes.

Profiting From Carry Trades And Interest Rate Differentials

Swing traders believe that stocks tend to swing up and down in the short term and that they can profit by buying at the bottom of the swing and selling at the top.

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This strategy involves buying and selling stocks within the same trading day, targeting to profit from small price movements.

Day traders use technical analysis and other tools to identify short-term trading opportunities and make quick trades to take advantage of them.

It involves using powerful computers and algorithms to buy and sell stocks at high speed, aiming to profit from small price movements. High-frequency traders often hold their positions for only a few seconds or less.

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