Thursday, December 17, 2009
Crash and Carry
This article discusses new research regarding the possibility to make steady profits from "carry trade." Carry trade describes a certain foreign exchange trading scheme where borrowing cheaply in a “funding” currency can exploit high interest rates in a “target” currency. This is pertinent because the U.S. dollar has recently become a prime currency for carry trade (due to the recession and America's near-zero rates).
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I myself stumbled upon this very interesting article just a few days prior and couldn’t help but think that perhaps America’s shining “City upon a Hill” image has begun to grow faint. Increasingly low interest rates in the United States have transformed a once esteemed invested currency into a “funding” currency. This, coupled with a severe trade imbalance could spell D-I-S-A-S-T-E-R for the US.
The “Carry Trade” theory is certainly plausible and has been thoroughly back-tested, however, it seems to me that this phenomenon may fall short in the world outside the classroom window. Even as Oscar Jorda and Alan M. Taylor explain in they’re article, The Carry Trade and Fundamentals: Nothing to Fear But FEER Itself, predicting the Fundamental Equilibrium Exchange Rate (FEER) only solves half the puzzle. But with risk comes reward and those willing to take that chance may find rather sizable returns.
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